Avoiding Tax Pitfalls: What Landlords Need to Know Before Filing

Filing taxes is stressful for everyone. But it’s particularly tough for landlords, as it can feel like there are so many things that might go wrong. 

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What is tax deductible? What isn’t? What pitfalls might you not even know about?

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You’re not alone if you’re struggling.  As Jeffrey Zhou, CEO and Founder of Fig Loans says, “Taxes, like any aspect of finances, can be very stressful. Getting it wrong can have financial consequences and potentially serious legal consequences too.”

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We’re going to dig into what you need to know before filing your taxes—highlighting some common mistakes and potential tax pitfalls. Whether this is your very first year as a landlord or you’ve been in the rental business for years, we’ve got you covered.

Here’s how to get your taxes right.

Step 1. Know Your Rental Income

It might sound obvious, but you need to know exactly what you’ve earned as a landlord in order to file your taxes accurately. Your income isn’t just the rent you charge. Rental income may also include things like the security deposit plus any advance rent that you’ve been paid, as well as any late fees. It also includes extra payments from your tenants, e.g. to cover damages or maintenance costs.

The IRS advises that if you keep some or all of the security deposit (e.g. because the tenant breaks their lease by leaving your property earlier than agreed), you need to include that amount in your income for that year.

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Jonathan Feniak, General Counsel at LLC Attorney says, “This is one area where some landlords go wrong. They don’t report all the income they need to, because they mistakenly think that it doesn’t count.”

Of course, it’s also vital that you keep records of rent paid. That might be simple if you only let out a single property that’s occupied all year, but could be much more complex with multiple properties and some vacancies.

Step 2. Understand Deductible Expenses

As a landlord, some of your expenses are deductible from your taxes … but not all. 

You don’t want to pay extra taxes unnecessarily, so it’s important to know the expenses you can deduct.

Equally, you don’t want to get into trouble for deducting expenses that aren’t allowed—so you need to know those too.

Kathryn MacDonell, CEO at Trilby Misso Lawyers says, “It should probably go without saying, but you can’t deduct expenses that don’t relate to your rental property. If you carry out essential repairs to your own home, those definitely aren’t deductible on your tax.”

Common Deductible Expenses

You can usually deduct:

• Mortgage interest
• Property taxes (on your rental property)
• Property insurance premiums (on your rental property)
• Repairs—but, importantly, not improvements
• Utilities and HOA fees, if you pay these rather than the tenant
• Overnight travel expenses, if you need to travel away from your city/area to your property
• Depreciation of your property

Landlords don’t always realize that travel expenses and depreciation can be deducted. While travel expenses are normally straightforward to track, accounting for depreciation can seem more complex.

Step 3. Know How to Handle Depreciation

The IRS understands that real estate will naturally lose value as it ages. You can claim this depreciation as an expense. For residential properties, depreciation is normally counted across 27.5 years, with the value of the property being depreciated at a rate of 3.635% each year. 

Note that depreciation only applies to the property itself, as this has a “determinable useful life.” The land that your property is on doesn’t depreciate as the land won’t get used up.

Deducting depreciation lowers your tax bill in the short term. But when you sell (or transfer) your property, you may need to pay back money through depreciation recapture. Essentially, if the property ends up selling for more than the depreciated value, it’ll be subject to depreciation recapture.

At this point, any depreciation you’ve claimed will be taxed as ordinary income, up to a rate of 25%. It’s really important that you understand depreciation recapture so you don’t get hit with a surprise bill later on.

Gary Hemming, Owner & Finance Director at ABC Finance explains, “It’s easy for landlords to overlook the impact of depreciation recapture when selling a property. Make sure you’re prepared for this or it could be a nasty surprise.”

Step 4. Be Aware of Key Tax Forms and Deadlines

If you feel overwhelmed by the paperwork involved with being a landlord, you’re not alone. Plenty of landlords struggle with tax forms. 

Getting to grips with this begins with knowing what the key forms are:

• Schedule E (Form 1040) – Form 1040 is the annual income tax return form for individuals in the USA. The Schedule E section of this form, Supplemental Income and Loss, is where landlords need to report their rental income and and allowable expenses.
• Form 1099-NEC – If you used suppliers and/or contractors for your rental property during the year, you may need to issue them a Form 1099-NEC.
• Form 1099-K – If you got rent payments (of over $600) through a card, Venmo, or other third-party payment software, you’ll need to file a Form 1099-K.
• Form 1099-Misc – You may need to file this form if you collect rent in cash, or as a check.

Important Deadlines

Normally, the deadline for filing your annual tax return is April 15, unless this falls on a weekend or holiday, in which case the deadline is the next business day.

You’ll also have quarterly estimated tax payments due on (or very soon after) on every Jan 15, April 15, June 15, and Sept 15.

What About Rental Income and Self-Employment Taxes?

Rental income isn’t usually subject to self-employment tax—but there are some situations where self-employment tax applies to landlords.

If you’re a real estate professional (e.g. an agent or dealer) or if you provide substantial services to your tenants, you may need to pay self-employment taxes. It’s a good idea to talk to an accountant about this.

For most landlords, however, their rental income counts as passive income, not self-employment.

If you run a separate business in addition to being a landlord, it’s important to differentiate between your passive rental income and your self-employed income.

Common Questions About Tax Filing for Landlords

Some questions come up frequently from landlords about taxes. Here are answers to three things you may have been wondering about.

1. As a landlord, do I also need to pay self-employment taxes?

Rental income isn’t usually subject to self-employment tax—but there are some situations where self-employment tax applies to landlords.

If you’re a real estate professional (e.g. an agent or dealer) or if you provide substantial services to your tenants, you may need to pay self-employment taxes. It’s a good idea to talk to an accountant about this.

For most landlords, however, their rental income counts as passive income, not self-employment.

If you run a separate business in addition to being a landlord, it’s important to differentiate between your passive rental income and your self-employed income.

2. Can I deduct expenses even if my rental unit isn’t occupied?

Yes, you can normally deduct expenses for your rental property even when it’s not occupied. Your property has to be available for rent—and you should be actively trying to get a tenant. 

You can deduct ordinary, necessary expenses like mortgage interest, property taxes, insurance premiums, repairs, and depreciation. 

If you need to replace something essential that was broken by the previous tenants, like a bed, that should be deductible.

You can also deduct the costs of advertising and marketing the property, e.g. printing flyers.

Important: If you use the property for “personal use” for more than 14 days while it’s vacant, then what you’re allowed to deduct may change. 

3. What’s the difference between a repair and an improvement for tax purposes?

Landlords can (and should) deduct the cost of repairs from their taxes … but improvements aren’t eligible.

So what’s the difference?

A repair restores the property to its original condition or value. If the kitchen faucet begins to leak and you pay to have it fixed, that’s a repair. 

An improvement enhances the property, probably increasing its value. If the kitchen sink is in perfect working order but you remodel the kitchen, adding a new sink, that’s an improvement.

At one point, replacing single-glazed windows with double-glazed windows was seen as an improvement (so not deductible). Today, double-glazing is the standard, so replacing single-glazing with double-glazed windows is generally considered deductible as a repair.”

Getting your taxes right can be daunting, but by avoiding the pitfalls we’ve covered—and discussing with your accountant when necessary—you can be confident that you’ve filed your taxes correctly. 

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