The preparation of tax returns on rental properties is not that difficult to do properly. Why is it that I have so many new clients coming in where their prior returns are glaringly wrong? In our many years of dedication to the accounting industry, our firm Accounting Solutions Ltd. has specialized in handling the needs of developers and landlords for over twenty years. The property rental market is a realm where there is certainly money to be made, especially for those looking to propel their net worth while generating a steady stream of income. The one downside that we see is inexperienced landlords making dire mistakes on their tax returns that cost them money due to easily amendable mistakes. Since we are proud to provide the best accounting advice and information that the city has to offer, we have assembled a list of five common errors that people tend to make when filing their returns.
1.) Security Deposits = Liabilities and then Income: Unless you are in a situation where this money has already been returned to a tenant, security deposits must first be shown as a liability on your balance sheet. At this point it is not considered income. But at the end of a lease, if repairs are necessary, the entire amount or a portion is always considered income. Since this income is typically required to repair the property, all of the deductions to make those repairs generally create enough expenses to negate a taxable event.
2.) Declaring Rental Income: Rental properties are generally cash basis taxpayers. As such, within the year that rent is received, it must be declared as rental income. We sometimes see landlords failing to include the last month of a year, thinking that it not being due yet discounts it from the declaration. If a rent is received it is generally income in that taxation period. If handled improperly, this can lead to significant monetary penalties, interest, and additional tax.
3.) Depreciation Isn’t Universal: When calculating depreciation, realize that furnishings within a building vs. the property itself are depreciated at different rates. While residential rental property within the Chicago area is depreciated using a time period of 27.5 years, furniture and other non-attached items within the property boundaries typically depreciate over five years.
4.) Tenant Expenses Can Count as Income: This nuance of the property rental business is something that tricks many landlords when tax season rolls around. When tenants pay you for something, such as repairs to your property, this must be declared as income by the landlord. Deductions to complete the work also apply. You should be declaring both income and expenses in this instance.
5.) Keep Your Documents Handy: Always make sure that everything you do, from the rental agreements to the costs of calling a plumber, are thoroughly documented. If you are ever audited and lack these files as proof of your expenses, then the expenses shown on the return could be disallowed leading to additional tax, interest, and penalty. Being organized is key. This should certainly be handled by an experienced CPA.
For anyone looking at investing in property, we hope that the aforementioned tips will help you prepare effectively for tax season. If you have any questions, or would like to seek further advice, feel free to contact us via telephone or email. Our consultation can ensure that your property will be an investment that keeps on giving.