Everything You Need to Know About Rental Income Tax

It’s critical to declare rental income on your taxes if you own an investment property and receive rent from your renters. However, you can deduct expenses related to the upkeep of your rental property. In other words, if you’re a first-time landlord, submitting your taxes will be more difficult. There are numerous advantages to planning ahead for these taxes. A financial advisor can assist you in developing a tax strategy if you need assistance with taxes.

Taxes on Rental Income: What to Declare

The amount of rental income you report on your taxes is determined by your accounting technique. The “cash basis technique” is used by the majority of people. This method necessitates reporting income as it is received and costs as they are paid out. However, some organizations employ the “accrual” accounting system. This method counts earnings when they are earned rather than when they are received.

You’ll probably employ the cash basis method if you’re merely a private citizen with a rental property. That is, any rent money you get will be counted as income in the relevant tax year. When adopting this method, the IRS says you can include advance rent, which the agency defines as any cash you receive from a tenant before the period it covers. If you sign a two-year lease with a tenant and get first-year rent payments along with some payments for the following year, you must record all of these payments as rental income in the tax year in which they were received.

You might be permitted to count your tenant’s security deposit as well. If you utilize the security deposit as a final rent payment or if you use all or part of it as compensation for damage caused by tenants, you can do so. However, if you collect a security deposit with the aim of returning it when the renter vacates, the money is not considered income.

When a tenant makes an in-kind payment, you can count it as revenue if it spans a certain number of months. Let’s imagine you and a tenant agree to take a good or service from each other in exchange for one month’s rent. You have still received a month’s rent in the eyes of the IRS. This means you’ll have to report the rent as income when you pay your taxes for that month.

Other types of rental income that landlords should declare include: For tax purposes, if a renter pays you to get out of a lease, that money is considered rental income. Regardless of your accounting approach, you must report the payment in the year it is received. These payments constitute as income for you if your renter covers any building expenses that are not required by the lease agreement. If a renter pays for a repair or utility not specified in the lease and then deducts that payment from his or her rent payment, it will be considered income.

What is the Tax Rate on Rental Income?

Whether your rental business is classed as passive or non-passive affects the tax rate on rental income. Rental properties are often considered as passive income and taxed as such. Property development, building, operation, management, or leadership activities are all part of a non-passive rental business.
Another consideration to make when determining the rental property income tax rate is whether or not the property owner is an active participant in the rental property. This is a term that describes the type of management decisions that are made. An investor may be deemed an active participant if they are the one in charge of property management. Each of these factors is significant because, in addition to calculating the tax rate, they might affect the deductions that a property owner may be qualified for.

How is rental income calculated?

Add up the payments you received for the rental property for the calendar year for which you are filing a tax return to get your total taxable rental income. This includes the following:
Rent is due. The sum of all renters’ regular and prorated rent payments.
Rent is paid in advance. If a renter pays the last month’s rent in advance when they move in, you must record the amount in the year you receive it, not the year the tenant moves out.
Security deposits that have not been repaid. Any portion of a security deposit that you keep after a renter moves out. You don’t have to declare the security deposit if you return it.

Fees. Renter fees, such as lease termination costs, are collected.
Rent was paid in exchange for services. If your tenant agreed to paint their own flat in exchange for a month of free rent, you’ll have to report that as one month’s rent income.
After you’ve calculated your gross rental income, subtract deductions and depreciation to arrive at your taxable income.

What can you deduct from rental income?

You can deduct the expenditures of the rental fees on your tax return as long as they are regarded “ordinary and essential.” Expenses that are tax deductible include:
Interest on a mortgage
Property tax is a type of tax that is used
Repairs
Utilities
Insurance for homeowners
Cleaning and maintenance of advertisements
Fees charged by a homeowners’ association or a condominium

You may not be able to deduct all of your rental expenses. Improvement costs, such as restoration, betterment, or adaption to a new use, are not deductible. Depreciation, on the other hand, can be used to recoup the cost of upgrades. Consult your tax preparer if you’re unsure whether a particular expense is deductible.

How do I report a rental activity on my tax return?

Schedule E: Supplemental Revenue and Loss is where you report the income and deductions from rental properties as an individual. Schedule E’s entire income or loss is carried over to page 1 of your Form 1040.
Use Form 4562: Depreciation and Amortization to track rental depreciation.

What are passive activities and how do they affect me?

Rental properties, in general, are passive activities by definition and are subject to the passive activity loss regulations. These regulations are extremely complicated. In general, the passive activity restrictions limit your ability to use net passive losses to offset other sources of income.
However, there is an exception: if you actively participate in a rental real estate operation, even if it is passive, you can deduct up to $25,000 of your rental loss. To actively engage, you must:

hold at least 10% of the property and have authority over significant management decisions such as authorizing new tenants, determining rental conditions, and approving improvements, among other things. (No, you won’t be mowing the yard or fielding late-night phone calls from tenants about a clogged toilet.)
However, when your income rises, this exception will be phased out.
If your adjusted AGI exceeds $100,000, the $25,000 rental real estate exception is reduced by $0.50 for each dollar above $100,000.
When your modified adjusted gross income surpasses $150,000, the exception is totally phased out.
Example:

Phil and Mary have a $90,000 adjusted gross income and a $21,000 rental loss for the year. They took an active role in the rental. Even though it is a passive loss, their full rental loss is deducted because their adjusted Adjusted Gross Income is below the $100,000 phase-out line.
They would have been limited to a deductible loss of $25,000 for the year if their loss had increased to $28,000.
The $3,000 nondeductible amount is a passive loss that is carried over to future years until it is allowed to be deducted under the passive loss tax regulations.

If you’re married and file a separate tax return from your spouse, and you lived apart from your spouse at all times during the year, the maximum rental real estate loss exemption for you is $12,500, with the exception phasing out at modified Adjusted Gross Income of $50,000 rather than $100,000.
The exclusion for active rental real estate losses is fully denied if you’re married and file separately but did not reside apart from your spouse at all times during the year.

You may need to complete Form 8582: Passive Activity Loss Limitations according to IRS instructions to compute your deductible loss.
You may be qualified for a favorable special rule if you spend a significant amount of time in real estate operations during the year.
The passive activity requirements do not apply to losses from certain rental real estate activities for so-called real estate professionals (as defined by IRS standards), which means the losses can normally be fully deducted in the year they occur.
Consult IRS Publication 527: Residential Rental Property for further information on this favorable special rule (Including Rental of Vacation Homes).