Rental real estate is a very popular investment in most of our clients’ portfolios. I think people like the fact that it is so tangible…people can see and touch it. Compare that to stocks and bonds and you will understand my position. However, real estate is not simple. Its not simple to consistently make good returns from real estate and the tax laws concerning real estate can be quite muddled and complex. For example, rental income and expenses….

Rental Income

Rental income includes all payments in cash or in kind for the occupation of property. Rental income is reported in the year it is received not for the period of use.

  • Advance rent – taxable when received
  • Security deposits – if to be used for the last months rent, then taxable when received
  • Expenses paid by the tenant – if expenses would have been obligation of the landlord – taxable to landlord in year paid.
  • Property or service in lieu of rent – taxable at FMV when received.

Rental Expenses

Expenses that are ordinary and necessary to conduct the rental income producing activity are deductible rental expenses. Such as:

  • Advertising
  • Commissions
  • Depreciation
  • Home office
  • Insurance
  • Mortgage interest
  • Property management fees
  • Property taxes
  • Software, technology, tools, etc.
  • Travel and mileage

Because of “depreciation recapture” I have heard several people mention that they didn’t want to take any depreciation deductions. Very bad idea! You will have “depreciation recapture” whether you benefit from the deduction or not. The law reads “depreciation allowed or allowable” which means you will recapture the depreciation whether you take it or not. Also, good time value of money management dictates taking a deduction early and income later. The final reason is the tax rate arbitrage. The “depreciation recapture” income is taxed at a 25% maximum. The deduction could have benefited you at a higher tax rate.

Leave a Comment