Rental Properties: What do I need to Know?

We commonly get asked, “should I buy a rental property and if so, what information do I need to keep for tax purposes?”  The answer to the first question relies heavily on your overall financial picture and whether you can afford to make such a purchase.  It also necessitates a larger emergency fund (above and beyond your normal personal expenses) to safeguard you from vacancies, repairs, etc. 

When it comes to taxes, everyone wants to know what they can “write off” for tax purposes.  Below is a list of items to keep track of every year while owning rental property.

• Mortgage interest

• Property taxes

• Homeowners (or any other) insurance

• HOA dues

• Cleaning and maintenance expenses

• Commissions/management fees if using a management company

• Repairs

• Supplies

• Utilities

• Time spent rented (if also used personally)

• Property improvements (ie. new roof, new appliances, new flooring)

While many expenses are taken in the year they occur, most property improvement expenses will be depreciated over a certain time period.  You are also able to depreciate the actual property over 27.5 years (for residential real estate).  It’s quite possible to be cash flow positive on a rental property but have a loss for tax purposes because of depreciation.  

Your rental income and expenses go on Schedule E of your personal income tax return.  The net of these numbers is transferred to the front page of the tax return and used to calculate your total tax.  If the rental property has a net loss, then you may be able to reduce your overall taxable income, (with some limitations).

Many clients ask if forming an LLC or partnership would reduce the tax impact of owning a rental property. The answer is “no” - it does not change the tax for rental properties, as it still flows to your personal return.  However, forming a separate business entity may give you some liability protection.

If the property is a home that you also use, say for vacation purposes, the expenses will be allocated between rental use and personal use.  Typically, the split between rental and personal use is based on a ratio of days rented versus used personally.

Owning rental property can be a good investment, but it may not be for everybody. If you have questions about rental property related to your personal situation, please feel free to reach out to us.