From Taxes to Budgets: An Accounting Blog

Posted on: 30 March 2023

More and more Americans are realizing the benefits of creating a secondary source of income through rental properties. But what about income tax on what you take in? Can the tax treatment of your rentals make this option even more profitable? Yes, and here are a few ways that this happens. 

1. Not All Income Is Income. While most forms of income a landlord receives are taxable, this doesn't apply to everything. The most common excludable income is a refundable security deposit. Because you will potentially return this money when the tenant leaves, it's actually a liability on your books until that happens. 

2. You Can Deduct Expenses. Some of the biggest tax breaks from rentals come in the form of expense deductions. You can deduct things like maintenance and repair costs, fees for management or landscaping, utilities you pay, insurance, mileage traveling to and from business activities, HOA fees, taxes, and interest on mortgages. These add up. 

3. Depreciation Is a Big Deduction. The other large tax break for rentals is known as depreciation. Depreciation means deducting a portion of your investment in a capital asset (real estate and other major investments) each year throughout its lifespan. Because depreciation is not a tangible expense, it's not a cost you pay but it is a cost you can deduct. Special depreciation may even let you take higher deductions upfront. 

4. You May Claim Losses. Small landlords are often categorized by the IRS as engaging in passive activity, which limits how they can use a loss on their taxes. However, some landlords whose primary form of income is their business may be able to deduct losses. A tax loss can result even if you did make a profit, depending on how many expenses and what depreciation you claim on your taxes. 

5. Special Exchange Rules Exist. Finally, when it's time to sell a property, you may get one final tax break out of it. This is known as a Section 1031 like-kind exchange. It's a complex IRS transaction, but it essentially lets you exchange one property for a similar property but delay declaring the taxable profit until you sell the new one. 

Where to Learn More

The income tax treatment of rental income and expenses can be complicated. The best place to begin is to meet with a qualified tax preparation service in your state. With their guidance, you'll minimize taxable income and maximize your profit as a landlord. For more information, contact a company like Taxes- The Balance Sheet.