If you’re a landlord, the last thing you want is an audit from the IRS, but it’s a challenge you need to be prepared for. Proper record keeping and an understanding of how tax law works are essential to protect yourself legally and financially. Here is a guide to ensure you know the ins and outs of tax law, and have the right strategy to save on taxes without crossing the line into illegal territory.
Record Keeping the Right Way
Perhaps the most important step you can take is maintaining excellent records. Keep an Excel spreadsheet of your expenses and income, regardless of whether it was a small repair or the cost of a consultation with a real estate lawyer. You may also want to have a separate spreadsheet for each building or rental space. Keep all other paperwork related to your rental activity well organized and cataloged.
If you have employees, such as a building manager, you need to have employment tax returns, payroll tax documents, and employee health insurance documents. These records must be stored for at least four years.
Travel Deduction Safeguards
Certain travel deductions may face a high level of scrutiny depending on what you’re claiming. It’s perfectly legitimate to claim deductions if you’re traveling to repair a property, speak with a tenant based on a rental issue, or meet with a contractor to discuss a renovation. However, be sure to keep a vehicle mileage log in case the IRS performs an audit, or they may hit you with a bigger tax bill with penalties on top.
Expenses you can deduct include plane tickets, hotel costs, public transportation or taxi costs, and even tips. You may even deduct up to 50 percent of your meal and beverage costs. Be sure to have backup documents and receipts to support your deductions.
Ultimately, you want to use common sense when taking a travel deduction. The claims must be appropriately related to your rental activity. If they aren’t, then don’t bother claiming them.
A Home Office Can Be A Red Flag
Many landlords also claim a home office. While you should definitely claim this deduction if you have a home office, you should also be aware that it does draw the attention of the IRS. You must ensure that you’re using your home office regularly for activities related to your rental business. At the same time, you must fulfill one of the following requirements:
Claiming You’re a Real Estate Professional
Some landlords claim they are a “real estate professional” in order to avoid certain taxes and to claim more deductions. This can be useful if you have another job while you’re managing your rental property portfolio. For example, rental income is considered “passive income” if it’s claimed against other “active income” like a salary for your job as a lawyer or doctor. In such circumstances, you will be unable to claim deductions beyond the excess income that you’re making on your properties.
Claiming you’re a real estate professional is a way to avoid these limitations. To do this, you must spend 750 hours a year dedicated to management of your real estate and you must spend at least 500 hours of that “materially involved” with operating your property. You must also prove you spend over half your time dedicated to real estate compared to any other job.
To prove all of this, you need to keep a daily log of each task you do, keep receipts, and provide details related to your tasks.
Using a CPA
If you plan to do your own taxes, it’s important that you have a thorough understanding of the different tax laws out there. However, it’s also not a bad idea to utilize a certified public accountant (CPA). They can provide an extra layer of documentation and expertise should you undergo an audit.
Ultimately, there are many ways to avoid unnecessary taxes as a landlord, but in the end you need to back up these deductions with thorough documentation and the right strategy.
Please note: These articles are for informational purposes and we advise you to consult an accountant for more specific information related to your situation.
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