Boundless Management

Income received from the rental of real property is considered taxable income and must be reported on the owner’s personal tax return. Rental activity for the year is detailed on federal Schedule E, and the net profit or loss is then carried forward to federal Form 1040. Yearly rental revenue is offset by all routine expenses related to the property itself, including a deduction for depreciation.

Depreciation as the Largest Rental Write-Off

Depreciation is a tax deduction to recover the cost of an asset and to account for the presumed decline in its value due to usage. Residential real property is depreciated over a period of 27.5 years, so the annual deduction is over 3 percent of the original property acquisition cost. The annual depreciation tax deduction also reduces the ongoing carrying value or basis of the property. In the event of a future property sale, the adjusted basis figure is used to calculate gain or loss at that time. Unlike depreciation, other rental property tax deductions require actual monetary outlays during the tax year.

Routine Expenses of Rental Property

Rental properties require various types of expenses in order to remain marketable. Interest applicable to a loan on a specific property is deductible. Personal travel to a rental property is deductible at the standard business mileage rate. The owner may incur costs for essential services such as advertising and cleaning. The legal aspects of property ownership may require payments for professional services. All expenses related to the promotion and maintenance of the property are deductible and are included along with depreciation on Schedule E.

State and Local Taxes

Most states levy an income tax, so rental income or loss affects those state returns as well. The county in which the property is located will levy its own property tax. If the property is located within a city, an additional property tax is likely to be assessed. Property taxes are fully deductible and are included with all other deductible expenses on Schedule E to determine overall gain or loss.

Security Deposits

An amount received as a security deposit is not included as current revenue if there is a possibility of its return to the leaseholder. If it is eventually returned to the leaseholder, it is never included in income. If the deposit amount is not returned at the conclusion of the lease for some reason, it is included at that later time as additional rental revenue.

Rental income reported on Form 1040 is combined with all other return components and is taxed at regular rates. Depreciation deducted on Schedule E effectively reduces taxable income even though the actual value of the property may be steady or even increasing in some cases. The owner’s basis is also adjusted downward by the annual depreciation deduction, increasing the likelihood of a future gain on a sale. If the market value of the real estate remains steady, the depreciation deduction successfully defers current income to a future taxable gain on a sale of the property.

If you’re thinking of purchasing rental property as an investment, it’s important to go into the process well-prepared. The more forethought you use in selecting, purchasing and managing your rental property, the better results your investment can yield. Here are ten important rental property tips help you find your way.

• Be prepared ahead of time

  Before you ever start looking for rental property, you should know what kind of property you want, which neighborhoods are desirable for purchasing rental property, how much you are willing to spend, comparable rents in the area, and how much you can reasonably assume to make on the deal. People who don’t have this research done in advance are more likely to make a bad purchase.

• Arrange your financing before purchase

  Pre-qualifying with the bank ahead of time will save you a lot of headaches in the long run; it will also be a safeguard against getting over-extended or wasting time looking at properties you can’t afford.

• Shop location, not just price

  A “great deal” in a high-crime area, for example, is not really a great deal, because your turnover and maintenance costs will likely be too high (and it might be difficult to sell once you’ve bought it). Look for property in desirable neighborhoods where property values are rising and rent rates are good. Even if you pay a bit more up front, you will reap better benefits in greater stability from your tenants and more profitability.

• Beware of complex structures and ‘fixer-uppers’

  Bear in mind that older structures, no matter how beautiful, always require more maintenance, with parts that may be more difficult to replace. These can yield good rent returns in the right areas (especially with renovation) but if you aren’t the type of person who thrives on repair work, look for simpler, newer structures with fewer maintenance concerns.

• Always have inspections done

  After you make your offer and before the closing date, pay for a good home inspector to go through the property with a fine-tooth comb. If significant issues arise that reduce the property value, you may want to try re-negotiating. At the very least, you don’t want any surprises once the deal is closed.

• Know the laws that govern landlords and tenants in your state

  Before you sign a lease with any tenant, you need to know your rights, as well as your responsibilities. Ignorance will almost certainly work against you at some point. Do your homework now and avoid getting sued or stolen from later.

• Always screen your tenants

  Follow up on the application, run a credit check, and call the references. If the tenant is local, drive by their current address and see how they are taking care of the place. Being lazy on this point can cost you dearly after the lease is signed.

• Make sure you are well insured

  Rental properties are likely to encounter a lot of wear, tear and damage. Make sure your assets are protected with enough insurance. You should also carry liability insurance to protect yourself against any possible lawsuits from your tenants.

• Keep money in the bank

  Don’t be caught off guard by a sudden slew of repair requests. Set aside funds for maintenance.

• Consider hiring a rental management company

  If you own a number of properties and don’t want to be a “full-time landlord,” or even if you don’t want the headaches frequently associated with rental properties, it’s worth hiring a good rental management company to handle the busy work for you. For a modest fee, the management company will screen your prospective tenants, collect rent, handle maintenance issues and even process evictions on your behalf.