Here are some best practices and tax considerations that will make managing rental real estate easier on you and your accountant:
- Keep a separate bank account for business. Even if you are just going to report the activity on Schedule E of your 1040, having the activity of the business separate will make book keeping and question answering much easier. If the property will be held by an LLC, this is necessary to help maintain the liability shield to show the distinction between the business entity and your personal assets.
- Only the interest on mortgage loans is deductible, not the whole payment. Additionally points paid on a mortgage are deductible ratably over the life of the loan.
- Establish a capital expenses account separate from the repairs and maintenance account. In the capital expenses account keep track of larger improvement or repair projects, remodeling, or asset purchases (computers, telephones, HVAC units, etc). At the end of the year, the capital expenses account can be easily adjusted to the balance sheet to capitalize and depreciate these assets.
- Depreciation considerations. Make certain to allocate part of the property purchase price to land. Look to guidance from the valuation or tax valuation as to a reasonable proration of these amounts.
- Deduct insurance premiums, as well as other business expenses (the ordinary and necessary expenses of carrying on a trade or business that are paid or incurred in the tax year). These are not deductible as a homeowner, but they are as a real estate business owner.
- Miscellaneous closing costs are deductible in the year of purchase. For example, title and escrow fees, title insurance, appraisal fees, loan application fees, and recording fees are all deductible in the year of purchase.
- Real estate income is passive income. Losses reflected on Schedule E will be carried forward to offset other passive income in future years. The exception to this rule is if you are a materially participating real estate professional. To meet this exception more than half of all working hours performed during the year must involve real property trades or businesses in which the taxpayer materially participates and these working hours need to be more than 750 hours.