If you own rental property there are a number of mistakes you should avoid. Here are some major ones:
- Forgetting the 14-day rule. As long as you rent out your property for a period of 14 days or less per year, you do not have to report rental income or otherwise treat rental activities as a business for tax purposes. But if you go over that 14-day limit — even for a minute — you will have to pay tax on the rental income. With the popularity of rental services like Airbnb, this mistake is happening more often than not.
- Mixing personal and rental business assets. If you rent more than 14 days a year, treat your rental activity as a business. Consider owning the property in a limited liability company and create a separate bank account for the rental property to keep your business income and expenses separate from your personal finances. If you don’t do this, you’re making it harder to report your net rental income every year on Schedule E.
- Getting fooled by the calendar. Rental payments are taxable in the month they are received, not during the month, they are applied to the rental balance. This means that if you receive January 2018 rent in December 2017 that income is taxable in 2017, not 2018.
- Counting the security deposit. Often a renter will give the landlord a security deposit and a rent payment. The security deposit is not considered income if it is returned to the renter at the end of the lease.
- Overlooking depreciation rules. You can depreciate residential real estate over 27.5 years, but remember to separate the cost of the land from the property value, as land is not depreciable. Also, depreciation that you could take but didn’t for whatever reason is “allowable depreciation.” When you sell the property you must reduce the basis by the amount of the allowable depreciation, which increases your taxable gain.
- Failing to consider the risks. Owning rental property comes with risk. You may lose a tenant and the property may sit vacantly, not be earning income. If your lender forecloses on your rental property and the proceeds do not cover the mortgage, they may come after your other assets, including your personal residence!
While renting the property can provide a lucrative income stream, there are many complicated rules to follow and mistakes to avoid. Reach out for a consultation to discuss your rental income strategy.