Renting out your home for part of the year can be a solid way to earn passive income during the summer months or for the busy tourist season. But before you do so, you’ll want to be aware of the tax rules, lest you get blindsided and end up paying more taxes than anticipated.
Here are some tax rules to keep in mind when renting out a house.
Renting Out a House: What’s Considered a Residential Property
According to the IRS, a "residential property" can be one of the following:
These are also known as dwellings. A dwelling is thought of as a residence if it’s used for personal purposes for at least 14 days of the year (or 10 percent of the days rented to others).
Divide Expenses for Personal Use and Rental Use
If you rent out your home for part of the year, you’ll need to divvy up your expenses for personal and rental use. Rental expenses are deducted on Schedule E (Form 1040), and personal expenses can be noted on Schedule A (Form 1040).
For tax deduction purposes, expenses must be considered "necessary and ordinary" — those are generally accepted and needed expenses in managing and maintaining your home. This could include insurance, marketing expenses, maintenance and repairs, HOA fees, taxes, interest and operating expenses. Other tax deductions include depreciation of your rental property.
If you pay for professional advice or services — legal, accounting, financing, etc. — don't forget to include those, points out Casey Fleming, a mortgage advisor and author of The Loan Guide, How to Get the Best Possible Mortgage. "If these [services or counsel] were part of helping you run your investments, it can probably be charged against the investment income," says Fleming.
One thing you can’t deduct is money you spent on improvements. Per the IRS, the cost of improvements will be recouped through depreciation.
Reporting Rental Tax to the IRS
Any rental income you earn will need to be reported to the IRS come tax time. Generally you’ll want to use a Schedule E (Form 1040) to report any money you make, plus any expenses on renting your residential property. Your expenses can be docked from your gross rental income.
Net Investment Income Tax
If your income is on the higher end, you might be subject to a Net Investment Income Tax (NIIT). A landlord tax of sorts, this tax applies to both your income and capital gains from rental property. If your rental real estate rakes in a net investment income that’s more than certain threshold amounts, you’re subject to paying a 3.8 percent net investment income tax (NIIIT).
For individuals, you'll pay NIIT on the lesser of either:
The net investment income
Anything above the modified adjusted gross income over:
$250,000 if you’re married filing jointly
$125,000 if you’re married filing separately
$200,000 in all other instances
Per the Tax Cuts and Job Act (TCJA), if you own rental property as an individual or as a pass-through entity (S Corporation, partnership or LLC taxed as either one), net income from your rental properties will be taxed via your personal federal income taxes.
When to Report Income on Rental Properties
If you pay your taxes on a cash basis (meaning you report your income and deductions the year they were actually received), you’ll need to report any income earned from renting your home the year you received it.
In other words, it doesn’t matter when the money was earned — only when it was received (such as when the money dropped in your bank account or when you deposited the check). For any rent received in advance (if tenants book online, for example), you report it the year you receive it.
Something to remember: When keeping track of all your income from the property, cash doesn't always equal income, says Fleming. Security deposits, for instance, are not income and you don't need to pay taxes on them as such. (Unless you use some of the security deposit to pay for unpaid rent or repairs upon move-out, at which point it does become income.)
Keep Your Records Up to Date
Of course, you’ll want to maintain solid records of all income and expenses. This will help you prepare financial statements, keep track of any expenses that are tax deductible, and make it that much easier to file your tax return. Plus, if you’re audited, you’ll have the proper documents and information readily at hand to provide the IRS.
Fleming recommends maintaining a separate account just for your for property income and expenses on your rental property. "That way, it's pretty easy to make sure your records are complete," says Fleming. "This isn't always possible, of course, especially if you are active in the management of the property. If that's the case, simply track every expense throughout the year. Even something as simple as a spreadsheet works fine."
For more information, check out the IRS’s Publication 527 on residential rental property
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