When it comes to filing taxes, rental property owners need a strategy to stay organized year-round. A proactive approach to tax prep puts you in the best position to maximize the valuable tax benefits available to real estate investors. Being organized also reduces the stress and time spent filing taxes each year, and helps you avoid costly mistakes.
In this blog post, we’ll share landlord tax tips to help real estate investors get organized ahead of tax season.
The IRS estimates 20-25% of U.S. taxpayers wait till the last two weeks before the April 15 deadline to prepare their tax returns. Rather than creating a last-minute scramble, start preparing your tax return as soon as you have all of the necessary documents and information.
Filing your tax return takes time — from tracking down missing documents to researching tax policies. If you’re in a rush, you’ll create extra stress and may make mistakes. TurboTax reports the most common tax filing mistakes are math errors, incorrect social security numbers, and missing signatures or dates — all of which can be avoided if you allow time for careful review.
Filing your taxes early also means you’ll receive your refund faster, before the IRS gets backed up. Finally, tax professionals get busier as the deadline approaches, so you’ll get more attention from them if you’re ready by March instead of April.
Rental property owners are able to deduct a variety of expenses to reduce their taxable income. The IRS allows you to write off ordinary and necessary expenses for operating your rental property — including the costs of mortgage interest, property taxes, rental insurance, repairs and maintenance, property manager fees, advertising, landlord-paid utilities, and more.
Landlords should also include depreciation and amortization in their tax deductions. Depreciation is an annual deduction that tracks a property’s loss in value over time — essentially distributing the cost of buying and improving a rental property over many years. (More on depreciation in tip #6). Amortization is similar to depreciation but tracks the intangible costs of acquiring property, such as the costs of obtaining a loan.
The IRS has very specific rules around depreciation, amortization, and deductions, so be sure to consult a tax professional if you have any uncertainty.
Once you know which expenses are tax-deductible, create a system to easily track them year-round. Instead of reviewing a year’s worth of transactions at once during tax season (or worse — digging through a shoebox of receipts), rental property owners can use online tools like Azibo to automatically track expenses as they happen. You can also use Azibo to tag expenses by property and Schedule E category to quickly itemize deductions when it’s time to file.
If you still have paper documents for some accounts, store them in an easily accessible space in your office or home — not on the kitchen table with the rest of your mail, where they will get lost or thrown out.
Whatever your preference for tracking rental income and expenses, be sure to create a system that you know you’ll stick to throughout the year. Keeping accurate, up-to-date records will help you simplify tax prep, save on accounting fees, and make the most of your deductions.
It’s also important to understand which expenses are not tax-deductible. The IRS differentiates between “repairs” and “improvements.” For example, you can deduct the costs of rental property repairs such as painting, patching holes in the wall, and fixing plumbing issues — basically anything that maintains a property’s current condition. On the other hand, capital improvements — such as renovations, additions or replacing major items like a roof — increase the value or longevity of the property and cannot be deducted since these costs are recovered through depreciation. Knowing whether to categorize your expenses as repairs or improvements will make filing your tax return a lot easier.
Different real estate strategies have different tax rates, depending on whether they’re a short- or long-term investment. Short-term real estate investments are assets you’ve held for one year or less, while long-term investments are held for more than one year. Investopedia explains that the tax on a long-term capital gain is almost always lower than if the same asset were sold (and the gain realized) in less than a year.
Buy-and-hold properties are typically long-term investments, while short-term real estate investment strategies include wholesaling, prehabbing, and flipping. As rental property owners, you must understand how to classify your investments come tax season, and which legal entities make the most sense for your business.
Landlords can further reduce their tax liability by conducting a cost segregation study. Cost segregation helps to accelerate depreciation by reclassifying major building components that likely need to be replaced in the future as personal property instead of real property. Examples include the driveway, landscaping, HVAC system, or even carpeting. This process allows the assets to be depreciated on a 5-, 7-, or 15-year schedule instead of the traditional 27.5- or 39-year depreciation schedule of real property — and results in a lower taxable income and higher cash flow for property owners. In fact, a cost segregation study can generate $30,000-$80,000 in tax savings per $1 million in building costs.
To maximize the tax benefits of this strategy, a cost segregation study should be conducted immediately (or within the first year) after purchase, renovation, or construction of a property. You can find out if your property qualifies for cost segregation by clicking below.
The best way to make sure you file your taxes correctly and take advantage of all available real estate tax benefits is to bring in a professional.
Rental property tax laws are complicated and constantly evolving, so hiring a CPA who specializes in real estate is well worth the cost. The potential upside of tax savings and higher refunds should balance out any accounting fees (which, by the way, you can write off). You’ll get peace of mind knowing your taxes are filed correctly without having to spend nearly as much time and effort figuring it out yourself — because as landlords, you’ve already got enough on your to-do list.
Owning an investment property is a great way to build wealth and work toward financial independence. By setting up systems to stay organized and track important tax information throughout the year, you’ll ensure a stress-free tax season while enjoying the full tax benefits of being a rental property owner.
Interested in hearing more landlord tax tips from real-world CPAs? Check out our free on-demand webinar below.
Azibo, Inc. and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.