It’s an occasionally awkward fact of life in this American economy: Scores of people who never have been landlords suddenly find themselves in the position of collecting rent checks every month because they can’t sell their homes and are installing tenants instead.
Then there are the owners of vacation properties who have turned their getaways into sources of income by renting them out.
The situation is sometimes awkward when both of the above categories of property owners find themselves running a business and struggling with the bookkeeping skills and the knowledge of tax-law basics the Internal Revenue Service expects, according to an expert on small-business tax considerations.
"Many novices fail to realize that when you put a place up for rent, you’re in a business," according to Abe Schneier, senior manager in taxation with the American Institute of Certified Public Accountants in Washington, D.C. "You have to have a set of books and records that properly reflect your income and your expenses."
Five things for novice landlords to know about keeping their books in a way that will satisfy the IRS:
1. You really do have to keep books, period.
"You can’t keep it on a scribble sheet," Schneier said. "When the IRS agent walks through the door, he’s going to throw that back at you. It’s not his job to do your bookkeeping."
But it doesn’t have to be complicated, he said. "It can be as simple as using (an online spreadsheet system) or knowing how to keep a ledger sheet."
Whatever the system, it needs to be exactly that — a system — that readily separates income and expenses and clearly identifies and details entries in both categories. Plus, landlords have to retain and organize their receipts.
2. Deductibility can be a nifty thing — maintenance, repairs and improvements that wouldn’t be of any benefit (at least immediately) to the average homeowner can be write-offs for landlords, he said.
Examples of expenses incurred on properties that landlords can deduct from their income include: advertising, cleaning and maintenance, mortgage interest, insurance premiums, legal fees, utilities, property taxes and other costs.
The IRS also allows landlords to claim depreciation on their properties — that is, that they "wear out" over the years, just as a manufacturer’s equipment becomes used or is made obsolete over time. This can be a valuable deduction, but rules are complex. The government explains them at IRS.gov and in Publication 946, "How to Depreciate Property."
3. Landlords also can deduct the costs of traveling to their properties to collect rent or to perform work on them — but only to a point, Schneier said.
"You have to be reasonable," Schneier said. "If it’s a question of driving 50 miles to collect the rent, that’s one thing. But if it’s a condo in Hawaii and you’re going to write off airfare and expenses to visit your vacation rental in Hawaii, you can run into some trouble.
"You have to show that the visit was substantially business-related," he said, with emphasis on "substantially."
The landlord of such a property must be prepared to justify to the IRS that it was important to be there for maintenance or repairs. The rule of thumb he advises landlords to observe is that at least 50 percent of the time spent visiting that property was devoted to its business needs, such as remodeling a bathroom or replacing furnishings, he said.
"You have to be able to show something — not just a receipt from Home Depot for a couple of light bulbs," he said.
(If you own a vacation home and rent it out most of the time, the IRS allows you to vacation there up to 14 days a year and still considers it a business, he said.)
4. Over the long run, landlords should be careful to differentiate between maintenance and improvements, he said.
That’s because when it comes time to sell the rental property, genuine improvements — the costs of replacing (not just repairing) the roof, windows or furnace, for example — can be deducted from the basis of your interest in the property and help reduce the capital gains on the sale.
And be careful how long you hold on to the records of such expenditures: The law requires you to keep everything at least three years, but no matter how long you hold the property, at sale time you’ll have to have those improvement receipts to justify your capital gains claims, he said.
5. Schneier, of course, urges landlords to seek out a tax professional in order to get the full benefit from rental property deductions, etc.
But the IRS does publish voluminous information at IRS.gov; in addition to the aforementioned guide to figuring depreciation, it also publishes a number of pamphlets that break down the details of legal and bookkeeping requirements.
Those include Publication 527, "Residential Rental Property" and Publication 523, "Selling Your Home," which has tax information on sales of homes that have been partly used as rentals.
