Every real estate investor is good at keeping track of the rent received each month, but some end up dropping the ball when it comes to keeping track of expenses.
Not expensing as much as you can could end up being an expensive mistake. According to the legal resource website Nolo.com, every $100 in unclaimed deductions costs the average middle-income landlord $25 in additional federal income taxes.
In this article, we’ll show you how to track rental property expenses to help keep your taxes as low as the law allows and have more money in the bank.
What Records Should You Keep for Rental Property?
There are several reasons why real estate investors should accurately keep track of the records for a rental property.
In addition to knowing if you are making a profit, accurate records will also help you report the correct amount of taxable net income. Secondly, by having an itemized list of the money coming in and going out, you can strategize on ways to increase your income and reduce your operating expenses.
Categories of Records
Records for a rental property fall into one of two categories:
- An itemized list or report of the income and expenses.
- Backup or supporting documents to prove the income and expenses are true and correct.
Types of Records to Keep
There are a variety of receipts and records to keep when you own a rental property:
- Tenant leases for the current and past tenants, going back several years.
- Legal documents and expense records relating to the leases, such as leasing commissions paid or court fees for an eviction.
- Proof of rental payments received, which are automatically recorded when your tenants pay rent online.
- Bank statements from the account specifically set up for your rental property to track the flow of cash, and to prove that you aren’t commingling business and personal funds.
- Copies of utility bills, receipts for materials and labor, and invoices for supplies and other services that directly relate to the rental property.
- Professional service fee statements from lawyers, accountants, and property managers.
- Advertising and marketing costs connected with filling a vacant property, including online tenant screening and lease preparation.
- Mortgage documents and records of loan payments made.
- Property tax and rental tax statements if your city assesses a sales or use tax for the monthly rent collected.
- Copies of your federal and state tax returns going back several years.
Most small rental property investors aren’t large enough to have salaried employees. If you are, you’ll need to keep track of salaries, benefits, employee taxes withheld, and taxes paid by the employer.
Are Your Expenses True and Correct?
Sometimes real estate investors hire a relative, friend, or business associate to help manage and maintain a rental property.
While there’s nothing wrong with keeping everything in the family, so to speak, be sure that the service charges are reasonable and at market. For example, if the going rate for tree trimming is $100 per tree and you pay $500 each, eventually the tax collector may begin to ask questions.
How to Track Rental Property Expenses
There are a lot of pieces of paper to keep track of to accurately report your rental property expenses. If you’re just beginning to build your rental property portfolio and only own one or two rental homes, you may decide that a simple spreadsheet is sufficient.
However, there are a lot of benefits to using an online system to track your rental property expenses, especially when some of the best online property management software is absolutely free.
Income and Expense Worksheet
The Zillow Rental Income and Expense Worksheet is free, easy to use, and customizable for the unique needs of your rental property business. The spreadsheet is in an Excel format and is designed for investors with one to five rental properties.
The worksheet also works in conjunction with Zillow Rental Manager for collecting online rent payments. To use the spreadsheet you’ll need to have the most recent version of Microsoft Office installed on your device.
Personal and Business Accounting Software
Quicken comes with preselected categories you can edit and uses a computerized checkbook and register so you can make payments online. Tiller Money automatically feeds transactions and balances to Excel or Google Sheets, making it a more advanced version of the Zillow worksheet.
Some of the best business accounting software programs are QuickBooks Online, Xero, FreshBooks, and Wave. Before investing in one of these programs, download a free trial version if possible, to make sure that the service is cost-effective and right for your needs.
Creating a demo rental property also helps you make sure the software can do everything that you want, such as tracking expenses for multiple rental properties or accounts receivable for rent payments due but not yet received.
Property Management Software
Three of the best free online property management software systems for landlords include Cozy, TenantCloud, and Stessa.
Of these three options, real estate investors may find that Stessa is the perfect option for tracking property performance and finances and creating a paper trail for income and receipts. The company helps both beginning investors with one or two rental properties, and sophisticated investors with large rental property portfolios, make informed decisions.
It takes just a few minutes to set up a property with automated income and expense tracking, and personalized financial and tax reporting to help maximize profits through smart money management. Best of all, Stessa is 100% free and has a mobile app for iOS and Android.
Reporting Rental Income and Expenses to the IRS
Here’s a summary of the tips from the IRS about tax reporting, record-keeping requirements, and rental property deductions to help real estate investors avoid mistakes.
What is Rental Income?
Rental income is the gross income you receive as rent. In addition to normal rent payments, rental income includes fees for canceling a lease, property or services received from a tenant in lieu of rent (such as painting the place in exchange for a month of free rent), and landlord expenses paid by the tenant, such as utilities.
Refundable security deposits are not considered to be rental income. However, if a security deposit is used as a final payment of rent, or if part of the security deposit is not refunded to the tenant due to excessive damages or an eviction, the security deposit is considered to be rental income.
What Deductions Can Rental Property Owners Take?
Deductible expenses on a rental property include mortgage interest, property tax, operating expenses, repairs, and depreciation. As a rule of thumb, ordinary and necessary expenses for managing, maintaining, and renting the property are all tax-deductible. This includes items such as materials, supplies, and professional fees.
Property improvements or capital expenses such as replacing a roof or installing a new air conditioning system must be depreciated over a number of years instead of being expensed in full the year the cost is incurred. This IRS article on Tangible Property Regulations provides more information about improvements.
How to Report Rental Income and Expenses
IRS Form 1040 or 1040-SR, Schedule E, Part I is used to report total income, expenses, and depreciation for each rental property. Form 4562 is used to figure the amount of rental property depreciation to use on Schedule E. For more than three rental properties, simply complete and attach as many Schedule Es needed to list the properties.
Note that if your rental expenses exceed your rental income, which may happen with a brand new rental property that is vacant, your annual loss may be limited due to passive activity loss rules and at-risk rules. Refer to Form 8582 Passive Activity Loss Limitations and Form 6198 At-Risk Limitations to learn if your loss is limited.
What Records Should You Keep?
Good rental property records help you monitor property performance, prepare financial statements, identify the source of receipts, track deductible expenses, and prepare tax returns and support items reported on tax returns.
If you are ever selected for an IRS audit, you must be able to document the information reported on your tax return. Documentary evidence includes receipts, canceled checks or bills, and deductible travel expenses directly related to the rental property. If you cannot provide evidence to satisfy the IRS you may be subject to additional taxes and penalties.
Where to Learn More About IRS Rental Property Tax Rules
The following links provide more information about the IRS rules and regulations for rental real estate:
- IRS Tips on Rental Real Estate Income, Deductions, and Rental Recordkeeping
- Know the Tax Facts About Renting Out Residential Property
- IRS Publication 527 Residential Rental Property
- IRS Publication 946 How to Depreciate Property
- Single Member Limited Liability Companies (LLCs)
Is Owning a Rental Property Worth It?
At this point, you may be wondering if owning a rental property is worth the trouble, especially when it comes to tracking income and expenses and reporting to the IRS.
While every investor will answer this question differently, according to commercial real estate services and investment firm CBRE, interest and investment in the single-family rental (SFR) housing sector has been huge. Both small-scale local investors and large-scale investment managers are exploring investment avenues and opportunities in the single-family rental sector.
When you consider the benefits of investing in real estate, it’s easy to understand why so many investors believe that owning rental property is worth it:
- Passive income from tenant rent payments while a local property management company takes care of the day-to-day details.
- Flexible exit strategy to keep renting while demand is strong, sell when the property significantly appreciates, or do a cash-out refinance to pull out equity and buy another rental home.
- Diversify investments by allocating some capital to real estate, which has a low correlation with the ups and downs of the stock market, meaning that rental property generally performs well in all market cycles.
- Tax write-offs from rental real estate include mortgage interest, insurance, maintenance, legal and professional fees, property management fees, property taxes, and travel expenses related to the property.
- Depreciation is another way real estate investors can reduce taxable net income, by deducting 3.636% of the property value from net income each year.
- 1031 tax-deferred exchanges are used to defer paying tax on depreciation recapture and capital gains by selling one investment property and buying another.
Owning rental property can be a good way to build long-term wealth. Passive income, tax benefits, and property appreciation can all add up surprisingly fast.
While most investors don’t like accounting or bookkeeping, tracking property expenses is a “necessary evil” when you own rental real estate. Fortunately, tracking income and expenses can be quick and easy when you have the right system in place.