It doesn’t matter if they have one rental property or 1,000. In the eyes of the IRS, landlords are like any other business owner and need to pay taxes on their profits. Luckily, costs associated with the property, including property management fees, are tax-deductible.
As the owner of rental property, it’s important to know about tax liability issues. Knowing what counts as income, and what is, and is not a tax-deductible expense will help eliminate surprises when it’s time to file a tax return.
We’ve explained in other articles how a property management company can make landlords’ lives easier. They can also simplify things when it comes to preparing for tax time.
DIY vs. Property Management Companies
Property management fees are tax-deductible, whether a landlord takes care of the property himself or hires a management company to do it. The difference is that in addition to all the day-to-day work, a do-it-yourself landlord is also responsible for keeping track of all of the expenses they incur. That means tracking every penny they pay for supplies or to hire someone to do repairs or maintenance.
On the other hand, when a landlord hires a company to manage a building, calculating property management fees is easy. It is simply the total they paid to that one company during the year. The management company may charge a flat fee each month or may invoice separately for certain projects or supplies. The burden of tracking all the details falls to the management company for their own tax purposes.
Tracking their own income and expenses will add extra paperwork for the landlord, but it can be done. The important part is recognizing what can be deducted and having the receipts to back it up. The last thing anyone wants to do is pay more tax than they need to. Knowing the rules will help ensure they’ve done everything possible to reduce their tax bill.
The taxable income for a rental property is a straightforward calculation. It is simply the amount of rent collected, minus deductible expenses.
What is Considered Income for a Landlord
Most landlords use the cash method of accounting. This means that they report income and expenses in the same year that they are paid. So, in addition to regular monthly rent received, the income also includes any security deposits. It’s common to require first and last month’s rent. Even though the last month’s rent is technically for a future year, it should be reported in the year it was received from the tenant.
Some landlords make arrangements with tenants to collect services in place of rent. For example, a tenant might offer to mow the property’s lawn all summer in return for a month or two of rent. In this case, the landlord would claim the amount of rent as income, even though he didn’t receive a check. But he can also claim the same dollar amount as a maintenance expense. The net taxable income is zero.
In the case of shared ownership, each owner claims a portion of the income (and expenses) equivalent to their ownership percentage. For example, if two people share ownership equally, they would each claim 50% of the total rent collected as income on their individual tax returns.
Deductible Expenses for Rental Property Owners
Landlords are entitled to tax deductions for much of the money they spend on their rental properties. Deductible expenses include maintaining the land, the structure, and the individual rental units. But other “costs of doing business” can offset income too.
Repairs and Maintenance Expenses
Any time a property owner needs to fix something for a tenant, the expenses are tax-deductible. Let’s say the pipes are leaking under a tenant’s kitchen sink. The cost of the new pipes can be claimed on the landlord’s tax return, along with all of the hardware needed to do the job. If a plumber is hired to do the work, the plumber’s bill can be added too.
Costs for general maintenance are deductible too. Cleaning and upkeep of common areas, utilities, landscaping and mowing, parking lot and sidewalk maintenance, snow removal, service on laundry room equipment—if it involves keeping the property in good condition for the tenants, it can be claimed on a tax return.
Instead of going into specifics about what can be claimed, the IRS rules simply state that the expenses claimed must be “ordinary and necessary.” This leaves some room for interpretation, but in general, expenses should be in line with what is generally accepted in the industry. For example, if the landlord replaces a broken doorknob and claims $2000 for parts and labor on a tax return, an IRS audit could be in his future.
Operating Expenses
As we’ve stated, running a rental operation is a business, and there are many expenses that go along with keeping it running smoothly. These are the areas where it is most beneficial to hire a property management company. Companies like Select Leasing & Management in St. Louis have the personnel and expertise to take these tasks off of the property owner’s hands.
Advertising available units is a tax-deductible expense. So are fees for credit and background checks of potential tenants. A landlord can claim legal fees associated with writing their leases, as well as eviction proceedings if necessary. These are all services that are typically included by management companies.
Expenses of Property Ownership
Finally, the costs of actually owning a property are tax-deductible. This covers mortgage interest, property taxes, and depreciation expense.
Major capital improvements or additions made to a property are not treated the same as repairs of maintenance. Some examples of capital improvements include adding units to an existing apartment building, installing a pool, or even a new roof. When something extends the life of the property, or changes it for another use, the cost must be depreciated over several years, rather than claimed as an expense in the year the money is spent. Only the amount of the current year’s depreciation is tax-deductible, instead of the entire project.
Property Management Companies Simplify Things
Property income and expenses are recorded on Schedule E of the property owner’s tax return. If a landlord owns only one rental unit, calculating his own taxes may not be too difficult. If they own a number of properties, it will become more complex. The same goes for landlords who manage things themselves instead of hiring a property management company.
Consider a company like Select Leasing & Management. They take care of the routine management of your rental properties. And when tax time comes around, your income and expenses will be easy to calculate.
It is usually best to contact an accountant to prepare the tax return or to at least ask advice. The goal is to minimize the amount paid to the IRS. Finding every available tax deduction for property management fees is the key.
