Managing Rental Finances: Taxes, Accounting, and Smart Property Decisions
Tax season is a stain on the calendar for everyone, but landlords have the added stress of trying to determine what they owe in taxes, what deductions they can take, and when to hire an accountant.
Taking the time to learn about rental income taxes and when to hire an accountant will allow you to keep more of your profits. Continue reading the article below, and be prepared, as tax time will go from being stressful to a walk in the park.
Is Rental Income Taxable and How to Stay Compliant
Understanding is rental income taxable helps landlords plan their finances. The quick answer to that is a Yes. Rental income is taxable, according to the IRS, just like income received through employment or business operations.
Understanding the tax implications of rental income often leads landlords to consider broader financial planning strategies to manage their assets effectively. This comprehensive approach to wealth management and financial security is what organizations like Primerica often advocate. This involves not only managing immediate tax burdens but also planning for long-term investment growth and retirement, ensuring that all sources of income contribute to a stable financial future.
Income that is considered taxable includes rent collected each month, prepaid rent, termination fees, and other types of services provided to tenants in lieu of payment.
The good news is that taxable income is not the total income collected. If a security deposit is paid back to a tenant, it does not have to be reported as income. Only amounts retained by the landlord for damages or unpaid rent are reportable as income.
In addition, all allowable expenses (repairs, mortgage interest, property taxes, etc.) can be subtracted from the total gross income collected to determine the net taxable amount of income.
When to Hire an Accountant for Your Rental Properties
Many small business owners wonder when to hire an accountant to manage their finances. Knowing the answer can be all you need to save money, reduce your stress, and prevent costly mistakes.
The following are five signs that you should hire an accountant for your rental properties:
1. You Own Multiple Properties
Once you have moved past one unit, managing the income, expense, and due date of each rental becomes complicated. A good accountant will assist you in separating your finances properly, take advantage of all deductions possible on a rental-by-rental basis, and ensure compliance with IRS regulations.
This way, you can focus on your role as a landlord and help tenants focus on their role as occupants.
2. You Are Unsure About Deductions
You may be wondering how to tell what qualifies as a legitimate "repair" vs. "improvement", or simply forget about depreciating. An accountant will clearly show you which costs qualify as deductions from your taxes based on the law and will ensure that you are claiming all that you can while remaining well within the boundaries of the IRS.
3. You Have No Time for Recordkeeping
Managing rental property is time-consuming in itself. Adding accounting/record-keeping to this list can cause problems. When a stack of receipts grows, and no one has touched your spreadsheet (or even made a copy), it is easy to make mistakes.
An accountant will take care of all record keeping, categorization, and organization for you to allow you to manage your properties while they do the number crunching.
4. Your Tax Situation Gets Complicated
Life-changing events such as selling a property, receiving inherited real estate, or converting a personal residence into a rental affect how much you will be taxed in significant ways. The process of triggering special rules for capital gains, calculating basis, and depreciating recapture is something that can be done best by a professional.
5. You Are Facing an Audit
There is no better way to instill fear than a notice from the IRS. When the tax man comes to visit, don't show up without an accountant. The accountant will represent you, communicate with the government on your behalf, and help explain your numbers to the IRS.
Practical Tips for Maximizing Profits and Minimizing Tax Risks
The decision to invest in real estate is an important one. Every day choices will either make your rental properties increase in value or add unnecessary stress to your life. These tips will help you to maintain as much of your rental income as possible while keeping your head above water with the IRS.
1. Keep Business and Personal Finances Separate
Use separate bank accounts and/or separate business credit cards for all of your rental income and expenses. By commingling these funds, you create accounting problems, and by doing so, you also raise the risk that the IRS may come knocking.
Separating your personal and business finances allows for easier tracking of your rental expense deduction, reduces the amount of time you spend during tax season, and provides you with a clear picture of how well your properties are performing financially.
2. Track Every Expense in Real Time
Do not wait to gather receipts (in April) to document all of the expenses as they occur; use a spreadsheet or app to track your expenses, such as repairs, supplies, mileage, etc., including the cost of a cup of coffee you had at a meeting with a contractor.
Small costs can add up quickly, and missing one or two could result in overpaying taxes on money you did spend running your business.
3. Understand the Difference: Repairs vs. Improvements
Repairs correct problems and are entirely deductible in the year you incurred the expense. Improvements increase the value of the asset and therefore need to be depreciated. The difference between these two items can cause many errors when making deductions (e.g., replacing a few roof shingles is a repair). If you replaced the entire roof, this would be an improvement.
4. Maximize Deductions Without Stretching
Commonly deductible items are mortgage interest, property taxes, property insurance, utility costs, marketing expenses, and professional fees. Depreciation is very powerful but rarely considered - you can depreciate a percentage of the building's value each year. Be aware of the legitimate deductions; do not attempt to deduct an item you cannot pay in full.
5. Set Aside Money Monthly for Taxes
Do not wait until tax time to have money set aside for taxes. Based on your net rental income, determine a rough estimate of 25-30%. Move this amount each month to a dedicated savings account. When your tax bills arrive, you will be able to pay them without stressing about having to come up with thousands of dollars by the end of April.
6. Review Your Finances with a Pro Annually
Schedule an annual meeting with your accountant to review your finances, as an expert will look for the things you have missed on your own; they will point out areas where you may be taking unnecessary risks and will assist you in planning for the upcoming year.
The value of having an accounting professional assist you can save you several times the cost of that hour alone in taxes saved and mistakes avoided.
Conclusion
Managing your rental finances doesn’t have to be a stressful experience in April. Knowing what will count as taxable income, keeping track of all your expenses accurately, and knowing when to seek out a professional can make managing your rental finances easier and grow your profit for the year.
Establishing a few good habits during the year will satisfy the IRS and your bank account. When should you hire an accountant to take over management of your finances? The answer is simple: before you really need them.
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