The new income buzzword is PASSIVE INCOME. This is the goal of having your money work for you to generate more income. This could include stocks, car washes, storage units, and possibly most popular: rental income. This comes in many forms, including AirB&B, VRBO’s, vacation homes, multifamily apartments, duplexes, and more. The idea is to acquire a livable home, rent it out, and the staying residents pay based on their stay, while you do nothing. Well…. Almost. There is A LOT to keep track of as a business owner, and it isn\’t just who is staying in your rental property. Good financial recording during the year is essential for when the time arrives to record:
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1040
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Schedule C
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Schedule E
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1099’s
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form 4562
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Schedule SE
………and that\’s just the beginning of rental forms to fill out! Whew!
Okay, so the real meaning of this post is to inform you of which expenses you need to track if you have rental homes. These are things your tax preparer will ask for, so it’s best to have it handy so you don’t have to think back over the previous year and try to remember what you bought at Lowes on a random date.
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How many days your rental is rented.
Scenario 1: You have a vacation rental and it\’s your first summer so you just had it rented out for 2 weeks the whole year. Guess what? You do not need to record rental income on your taxes if it was rented for less than 15 days.
Scenario 2: You have a vacation home in Cabo and your family stays there for 3 weeks, you rent it out for 12 weeks, and you let your Aunt Mary stay there an additional week for $25.00 total. In total, your house was lived in for 16 weeks. It was over 14 days so you have to record rental income on taxes. You stayed there longer than 2 weeks so it is no longer considered a rental home but a vacation home. (This is important because it is taxed differently). So you should be able to say that it was rented for a total of 13 weeks. According to the IRS, you cannot do that because you have to record family time (like your Aunt Mary) staying there too. One may argue, “Well she paid me to stay there that week!” Again, according to the IRS, the family cannot stay there AND count it as rented days, AND you must rent the house at fair market value- so her $25 contribution would not count anyway. Knowing how many rental days you (or family) stayed in the house vs how many days total anyone stayed there will help you file taxes correctly.
2. Expenses
Okay, okay, we understand that you want to write off as many expenses for the rental as possible — but what expenses can we write off? There are major differences for tax purposes between the cost of goods sold (COGS) and expenses. COGS are expenses that are paid for (in this case) to bring your rental property to its intended use. If the house needs new windows, flooring, paint, contractors, plumbing, and a new sink then those are COGS. Expenses are things that you pay for to operate your business.
For example, the gas to drive your car from rental property to Lowe’s, back to the rental is a business expense. Also, the price to list your home on a site for potential renters to see is an expense. Small tools you will use on other properties in the future are considered expenses. And also in 2020 and 2021, meals from restaurants to eat DURING your working hours with your other workers (not to come home to feed your family dinner every night) are 100% expensed (you must be able to explain how it was a work-related meal!) Also, cleaning fees, taxes, and insurance can be expensed.
3. Adding value to a property
Figuring out depreciation, asset value, and land value should just be left to the tax preparer year-to-year. But one thing you must keep track of is when you ADD value to your property.
Scenario 1: Maybe the roof is leaking and it\’s old. Replacing the roof in this situation is not adding value and you can expense the repairs it needs.
Scenario 2: Say you like the new design of a kitchen, but the kitchen in your rental honestly works just fine. Updating this kitchen would be adding value to the property and tax preparers need to know the dollar amount (i.e. receipt trails) of the value of the kitchen! This would change how the property depreciates since it may last 5-10 years longer than before the kitchen was updated.
4. Security deposits
You HAVE TO keep track of your security deposits! Security deposits are a LIABILITY back to the renter for when they leave, assuming they leave the property in great condition. If a renter gives you $250 for a security deposit, you cannot go and spend that money — you are held liable for returning that money to the renter when the contract expires.
5. How you receive payments
This one is not necessarily for tax benefits, but just to abide by the law. First, do not accept rent payments through Venmo. I see this way too often. It\’s entirely unprofessional (you are running a real business, not a craft out of your garage under the table). Second, the fees that Venmo charges are avoidable for those providing a service through Venmo. And if you have to use Venmo (which you shouldn’t) make sure it\’s a business Venmo account. I understand the ease of Venmo, and I use it for personal expenses, but never use Venmo for rental income — for more reasons than I care to describe here (maybe another post). A third, important note is that, by law, you have to offer more than one way for a renter to pay you. You cannot demand only check payments from tenants — you have to offer a second way in case they cannot write a check.
Wow, this is just the beginning of things that I believe you need to keep track of for your rental properties. I hope you see why many investors acquire a bookkeeper and tax preparer to assist with all the tracking needs. There are also some great tax benefits to owning investment properties when tracked properly with an accurate profit and loss statement. I highly suggest QuickBooks Online to help track these expenses. MileIQ is a popular app that many people use to track their miles to and from business locations. A third app that I recommend is TenantCloud. This system helps communication between you, tenants, property managers, and contractors (if something breaks). It also automatically invoices the tenants, tracks properties, holds notes, and the free version works well.
There\’s much more to learn about rental properties and the details of bookkeeping and tax prep. I highly suggest some videos on Youtube from IncomeDigs. Also, there are many books and podcasts, including Bigger Pockets. Books include “ABC’s of Real Estate Investing” by Ken McElroy, and “Buy, Rehab, Rent, Refinance, Repeat: The BRRRR Rental Property Investment Strategy Made Simple” by David Greene.
Feel free to contact us if you have other questions about organizing your rental finances or how to get started!
I am not a legal professional, attorney, or CPA. Take caution and do your research with the IRS website for more clarification.