Posted by Thomas G Kinsella, ATP

Rental Income Tax: Important Things to Know

Rental Income Tax: Important Things to Know

One of the issues that real estate investors have to deal with is taxes. There are various taxes with different implications on asset performance. It is not surprising that people with rental income might wonder how it is taxed. 

With various tax policies springing up, series of news cycles, and misconceptions on income taxes, one might easily get overwhelmed. The good news is that there are many things one can do to remain safe when it's tax season. 

A lot of people, including business owners, are guilty of believing false information about taxes. Your understanding of tax rates, the return filing process, and deductions all contribute to your success when it's tax time. This article sheds light on rental income taxes and how one can go about them. 

What Rental income can be taxed?

Whatever rental income that comes to you as a property owner can be taxed and must be reported; typically, rental income includes security deposits, payment of rents, fees from leasing, and other cash flow from a property. 

Even though the bulk of income on a property might arise from rent payment, one needs to include other income-generating sources. Commercial property owners, for instance, should pay good attention to this process called advance rent since leases can span several years.

Security deposits are also valid for rental income taxes, especially when they will be applied as the rent for the previous month. If there is such an agreement between a tenant and property owner, the funds will reflect as rental income when they were received. Conversely, if the investor will not use the security deposit for the rent for the last month, the tax on it will not be similar to rental income. 

One of the grey areas for many realtors is expenses paid by tenants like gas and power. All utilities paid by tenants will be included as rental income by the property owner. Even though utility costs are tax deductions that are eligible, it is essential for landlords to report initial income from tenant payments. 

Tax Rate on Rental Income

There are various tax rates on rental income, depending on the type of rental business – passive or non-passive. In many cases, rental property is usually classified as passive income and taxed as such. For the non-passive type, there will be property development, operation, construction, and other leading activities. 

Another factor that helps determine the income tax rate on a rental property is if the property owner participates actively. This involves the form of management decisions made. An investor who handles management responsibility might be classified as an active participant. 

Deductions Available for Rental Income 

The profit from a rental property is often pretty attractive to an investor until tax season comes knocking. This makes it essential to know the deductions that you qualify for. What makes deductions important is that they can be removed from your taxable income. When subtracted, they reduce your taxable income's overall value, reducing what you pay in taxes as a whole.

There are many deductions a property owner qualifies for. A few of them are:

  • Property depreciation: this refers to the loss in value of a property due to wear and tear. It is the most common deduction available to real estate investors. It can, however, be tricky to estimate the exact value that qualifies for this deduction.

  • Interest: this refers to the mortgage or loan interest that you pay as a property owner in a year. An investor can deduct any interest on credit cards related to business. It is one of the most significant deductions for rental income. 

  • Repairs: These are projects that make the property conducive and livable. Costs of fixing broken doors, repairing HVAC systems, etc., are repairs and are deductible from taxable income. 

  • Insurance: All insurance premiums that are part of the rental business can also be deducted. Examples are flood, theft, fire, etc. 

  • Home office expenses: You can deduct expenses for home office from your taxable income. To qualify for home office expenses, investors need to prove that the home is their primary business place. 

  • Legal Services: All fees you paid to lawyers, accountants, property managers can be deducted as expenses for operations.



Thomas G Kinsella, ATP
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