Tax season is stressful for everyone. If you’re a landlord, tax season may be something you dread each year, with so many different metrics to track and books to keep updated. Luckily the list below enumerates the top four accounting principles that landlords need to know to make taxes and bookkeeping a breeze.
#1: Know Deductible Expenses
There are a lot of potential deductible rental expenses that your business can write off come tax season. Knowing which deductions you can file for can reduce your tax bill at the end of the year and help you maximize your profit. Some potential deductions include mortgage interest payments, maintenance payments to contractors, repair costs, or lease cancellation fees.
To make the most of your deductions, it’s important that you have sound bookkeeping practices to keep track of all your income and expenses. The easiest way to do this is by utilizing property management software, like Innago, where your bookkeeping is automated. You can download these digital ledgers of transactions and send them off to your tax professional come tax season or analyze them yourself.
#2: Accrual or Cash Accounting
There are two main ways to conduct your accounting: accrual or cash method of accounting. Whichever method you choose, make sure you’re consistent and thorough with it to make the most of your choice.
Choosing which one to embrace depends mainly on how large your business is. If you have a big business, accrual accounting is the way to go. Accrual accounting is when you record income for when it is supposed to be in your account, rather than when it actually is. For example, if a tenant pays rent for both January and February on January 1st, you would record only the January transaction. Then, in February, you would record the February funds, even though they hit your account in January. This is useful because you can see the big picture of income and expenses during different time periods.
On the other hand, smaller businesses will probably benefit from using the cash accounting method. Cash accounting is when you record the transaction for when it actually happens. Using the example above, if the tenant pays for both January and February on January 1st, you would record both transactions for January 1st. This method is best used when you need to know an accurate amount that is in your account at any given point in time.
Keep in mind that you cannot use the cash method of accounting for your tax returns if your business maintains inventory, has gross receipts totaling more than $26 million a year, or is a corporation.
#3: Know Relevant Tax Forms
A tricky part about being a landlord and conducting your rental business’ bookkeeping is knowing what tax forms to give to which employees and when. The IRS has many rules regarding contractors and other types of employees that you may do business with, so knowing the relevant tax laws is important if you want to stay tax compliant.
A schedule E form is a form that landlords must fill out to report profit and loss from their rental properties. You can use this form to calculate your taxes owed for the year. On this form, you will match your expenses to the corresponding category, giving you an official document outlining your yearly income and expenses. Also, for every employee or contractor, you will need to fill out 1099 form.
Make sure you’re familiar with what forms you need to fill out and have access to during tax season, since you can incur penalties for neglecting to do so.
#4: Hire a CPA
Rental property accounting can be complicated. When you have a lot of other responsibilities as well, figuring out your taxes and deductions can be a burden. It’s easy to make an error when you’re new to accounting and bookkeeping, and these errors can be costly. It’s smart to consult an expert in the field when you’re unsure.
A CPA can advise you on certain tools and software that will make bookkeeping easier, and they can help you analyze your financial reports. Most importantly, they will double check your work to ensure you aren’t going to get penalized from the IRS come tax season.
Whether you’re doing your accounting yourself or hiring a professional, it’s important to know the basics of accounting for your rental business. Even if you’re hiring a professional to help you with your books, being informed and proactive is the best way to feel confident that you’re remaining within relevant tax law and protecting your business from potential penalties and audits.