If you have purchased a property to rent out, you have likely made a very smart financial decision. Being a landlord means – almost – guaranteed income, all year round, for long periods. If you’ve invested smartly, you will be making a good return on your investment, meaning some nice profits and extra income for yourself.
Whether this is your sole source of income or a bonus income stream, some taxes must be paid on rental income. However, there are deductions you can make from your gross income to ensure that you’re only paying tax on your net profit, as opposed to overpaying tax on gross profit. In this article, you will find some tips on rental income and tax deductions that you should know about as a property investor.
What is Rental Income
First, it’s important to understand rental investments. When buying a property to rent, it should make you a profit, otherwise, it’s not a good investment! Before you buy, there are a few calculations you need to do. Firstly, you should check your cap rate. You do this by comparing monthly property expenses with the overall income. This is then divided by the overall property price to see what your yearly return on investment may be. Most investors like to make a 7.5% cap rate, meaning you’re receiving 7.5% of the property’s value per year in gross profit.
Secondly, you should try and abide by the 1% rule. For example, if your property costs $250,000, its rental value should be around $2,500 per month. This is simply a good way of making sure that you are going to make a decent return, before analyzing gross profit margins.
So, before you pay any tax on this income, what can be deducted? There are some great property rental income calculators online that can help you see these deductions, showing you exactly how much your pre and post-tax profits will be. Let’s take a closer look at what is deductible, before working out how much tax you’ll have to pay.
Your mortgage itself – if you have one – will not be a deductible expense on your property. However, most mortgages charge interest during the duration of the loan. Say your monthly mortgage repayment is $250, of which $8 is interest payment. Over the year, you’ll pay 12x$8 interest payments. This amount can be deducted from your tax return.
No one wants to pay the same tax twice. Luckily, any tax you pay – up to the value of $5000 – on your property purchase will be deductible from your overall tax bill. If you are married or invest with a partner, this value may be able to increase to $10,000. The amount of tax you pay depends on where you decide to invest. For example, one of the main costs for those looking at property investment UK is stamp duty tax – a tax that those in England or Northern Ireland are liable to pay when purchasing property for residential or investment purposes.
Repairs and Maintenance
Owning a property often leads to repairs, maintenance, building works, and other unavoidable expenses. You never know when a pipe may burst or a crack forms in a wall. These are, fortunately, tax-deductible as they are often an unplanned expense.
Managing rental properties is never easy, especially if you have more than one. Oftentimes, landlords turn to property management companies to help them manage their portfolios. This costs money! You may also have decided to have insurance on your property – which is highly recommended! Once again, these costs are deductible from your overall profit, making your gross profit lower and helping you pay a little bit less tax.
Tax Filing Responsibilities
As with any job or any kind of income, you have to report your income accurately and on time to the IRS. To make your life easier, it’s highly recommended to keep good records throughout the year. Whether you choose to use paper or some modern accounting software, recording your expenses, income, and tax payments as you progress throughout a financial year will make filing your tax return a breeze.
Some software even helps you file the return automatically, just so long as you’ve kept everything up to date throughout the year. However, if you need a little help, you can always use a tax adviser or business accountant to help you submit your return. As a bonus, accountancy fees or tax adviser fees are usually tax-deductible!
These deductions will help you make sure you never overpay on your taxes. The best thing to do is make sure you keep on top of your expenses all year round, ensuring that you are not in a panic when it comes to tax return time. Use online calculators, software, and tax advisers to help make sure you never overpay and get the right deductions on your return.