While income and expense tracking isn’t the most enjoyable part of rental property management, it’s a step you shouldn’t skip.
Storing the occasional receipt and having a general idea of costs doesn’t cut it if the IRS has questions. You need exact numbers to back up your rental property expenses used to reduce taxable net income.
This article will explain how to accurately track your rental property expenses, what documents to keep, how to report expenses to the IRS, and more.
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The Importance of Staying Organized
I could go on forever about the virtues of being organized in any facet of business. But having your rental property finances organized is downright crucial and serves several purposes:
- Keeping track of your rental property expenses is a necessary part of determining whether you’re making or losing money.
- Tracking expenses helps you identify deductible expenses that can help reduce your taxable net income.
- Having organized expenses will both reduce your risk of audit—and ensure that you’re prepared to deal with an audit should you find yourself under the IRS’s microscope. (As long as you have the receipts and any financial reports you used when you filed your taxes, you should be able to back up your returns.)
- Keeping tax records for each real estate investment property can also help if any current or past tenants take you to court. For example, rental expenses might prove you performed necessary property maintenance and repairs for a tenant withholding monthly rent payments.
- Keeping track of expenses is also necessary if you file a claim with your landlord insurance provider. For instance, if you sustain property damage from a natural disaster, you’ll need to submit receipts to get reimbursed for repairs.
What Documentation Should You Keep for Your Rental Property?
The short answer is to keep everything. To give you an idea of what “everything” means, here are some examples of the documents rental property owners and real estate investors should keep.
1. List of Expenses Related to the Property
You will need proof that expenses are business-related, so keep receipts. The easiest way to track your rental expenses is to link them to a property. It helps to have a designated bank account to track purchases and monthly rent collected for each property.
2. Rental Income Collected and Proof of Receipt
It’s easier to track rental payments received online from tenants through landlord property management software. If you choose to collect rent through physical checks or cash for your rental real estate, make sure you create receipts with the amount paid and the date. You also need to track any late fees or other payments (e.g., parking).
3. Lease Agreements and Related Costs
Lease agreements contain important information, such as the security deposit, rent price, when rent is due, how late fees work, sub-leasing rules, pet fees, and the eviction process.
Don’t throw out tenant leases as soon as they move out. These contracts are essential for any litigation. You need to be able to show, in writing, whether you and your tenants lived up to your agreement.
4. Bank Statements
Bank statements should be from an account specifically for your rental real estate business. Bank statements from personal accounts that have non-business transactions take a lot of time to sort through when you go to prepare tax returns.
5. Utility Bills
Keep utility bills for your rental property and receipts for labor and materials. Utility bills paid for by the landlord are tax-deductible expenses. If your tenants reimburse you for utilities, you can still use it as a rental property deduction and claim the reimbursement as income.
6. Invoices with Professional Fees
Fees paid to lawyers, accountants, and similar professionals are deductible operating expenses as long as the fees are for work related to your rental property portfolio. Make sure to ask for receipts when you pay for these services.
7. Property Management Company Agreement
While I never hired a property manager to handle my properties, any landlord or real estate investor who hires a property manager should have a property management company agreement.
This agreement should clearly state the property management fees and the services included. Some property managers may charge an early termination fee for ending a contract early.
8. Maintenance Costs and Upgrades
Maintenance costs will likely fluctuate every month, so it’s important to track what you’re paying. You especially want a record of any property damage costs your tenants will be liable to pay.
Preventative maintenance costs, such as changing the filters on a heating and air conditioning system, are deductible. Repairs are as well.
When I was a landlord, I’d set quarterly reminders to myself to check my bank accounts statements for any expenses that might be considered a tax deduction to save time each year during tax season. Now, some accounting software for rental properties allow you to tag expenses as you pay them to make organizing these expenses easier and real-time. We’ll cover our top pick for this use case later in the article.
For more long-term projects like property upgrades or capital improvements, such as replacing a roof or installing new windows, have to be depreciated over time using a tax system called Modified Adjusted Cost Recovery System (MACRS) depreciation.
With any minor or major project like this, make sure to get an invoice for work done to your property. If you plan to deduct the cost, make sure an invoice for repairs or maintenance doesn’t include any verbiage that makes it sound like an improvement.
9. Mortgage Loan Documents
One of my favorite forms I’d get in the mail each year was my Form 1098, Mortgage Interest Statement. Each form contained information on the mortgage interest I paid during the year for my properties, and because mortgage loan interest for real estate investments is a deductible expense, it amounted to a tax savings statement.
Keep mortgage documents and records of all loan payments. Note that the deduction only applies to payments toward interest charges and not any of the payments on the principal loan amount. Further, you must be the primary borrower on the loan and actively make payments to claim the interest paid as a deduction.
10. Property Tax Records
You can deduct real estate property taxes, rental licensing fees, and occupancy taxes up to a certain amount. The IRS limits the deduction of state/local income and sales/property taxes to a combined deduction of $10,000 for married couples who file jointly or $5,000 for married people who file separate returns. This is referred to as the state and local tax limitation, or “SALT tax limitation.”
11. Tax Returns (State and Federal)
Keep tax returns for a minimum of three years after you file the return. There are certain situations in which the IRS recommends keeping tax returns for longer, including:
- If you report less than 25% of your gross income, you should keep records for six years.
- If you don’t file a return, you should keep records indefinitely.
- If you file a fraudulent return, you should keep records indefinitely.
Note that creditors or insurance companies might ask you to keep your tax returns longer than the IRS requires.
12. Tax Basis for Depreciation
Depreciation of real estate assets, aka the “wear and tear” on your rental property, is tax deductible over 27 1/2 years (39 years for commercial property). Keep in mind that only the physical property is depreciable, not the land.
Related: Is Rental Property Section 1231 or 1250?
Ensure the Accuracy of Your Rental Expenses
According to the IRS, you must have “documentary evidence, such as receipts, canceled checks or bills, to support your expenses.” Anyone deducting travel expenses has to keep records following the rules in Chapter 5 of Publication 463, Travel, Entertainment, Gift, and Car Expenses.
All of this documentation is vital to have on hand if you’re audited. Those unable to provide evidence of expenses may be subject to penalties and additional taxes for failure to substantiate the deductions taken on your return.
My advice? Cross-check your bank statements and financial records to make sure they match, or use software that matches the numbers for you.
Related: How to Run a Background Check for Rental Property
How to Track Rental Property Expenses
Keep your personal and rental property expenses separate. This will save you from wondering what each transaction is for and which property it relates to.
Create Folders for All Documentation
Folders, whether physical or digital (or both), will be your friend when tracking rental property expenses. I’m a digital-first person, but physical records are best if that’s the way that works for you. Everyone’s different.
You might have separate folders for lease agreements, mortgage loan documents, maintenance costs, rental income, and more. If you have multiple properties, you might have different folders for those as well.
Create an Income and Expense Worksheet
Make a worksheet that clearly shows all of your income and expenses. Besides rent payments, it should include late fees, maintenance costs, utilities, HOA fees, and any other money coming in or going out.
You should all be able to back up your numbers with supporting documents, such as bank statements or receipts.
Use Business Accounting Software Programs
Business accounting software can simplify rental property expense tracking and keep your cash flow in check. Accounting software can help manage invoices and expenses, generate reports, and more.
Use Purpose-Built Property Management Software (Specialized Rental Property Expense Tracker)
Generic business accounting software is better than manually tracking rental property expenses. However, software designed for rental property owners can automate expense tracking and manage other common rental property tasks.
- Available: Sign up here
- Price: Free
Baselane is an excellent choice for property management software. It automatically tracks income and expenses and has one-click smart categorization for Schedule E and property tags to simplify tax season.
Landlords, property owners, and real estate investors can bank with Baselane and open accounts for each property. There’s no limit on the number of accounts, whether you own a single-family rental or multiple properties.
It also provides a consolidated ledger for all transactions. Users can manually add, split, or hide transactions and attach receipts or leave notes.
Baselane’s automated online rent collection is another feature that simplifies rental property bookkeeping. When tenants make online rent payments, the money is deposited directly into the landlord’s bank account in as little as two days.
Each tenant’s rent payment is automatically tracked, and alerts are sent when rent is paid. There are options for automated rent reminders and late fees to save time chasing tenants for late rent payments.
Not only can Baselane track rental property expenses and rental payments, but it can also provide valuable insights about revenue and expenses month to month. Landlords can see real-time property metrics, such as net operating income, cash-on-cash return, and more.
The software also provides access to affordable landlord insurance, instant loan quotes, and more.
And Baselane is free. There are no fees for opening an account, ACH transfers, overdrafts, or bookkeeping. There is no account minimum and no monthly fees.
- Baselane is a complete rental property financial management system.
- Baselane's bank accounts for landlords have no fees and offer high yields on all balances (up to 3.77% APY as of 9/18/2024*), unlimited 1% cash back on debit card spend, and up to 5% cash back on home improvement spending.** Other features include check writing, same-day ACH payments, and up to $3 million in FDIC insurance.
- Baselane also offers bookkeeping, rent collection, analytics, and more.
- Special Offer ($150 bonus): Earn a $150 bonus after completing four steps with your Baselane Banking account. (1) Make a deposit of greater than $500 into a Baselane banking account within 30 days. (2) Maintain that average balance for 60 days. (3) Make more than $1,500 worth of mortgage payments within 90 days. (4) Collect more than $1,500 of rent via Baselane into Baselane Banking within 90 days.
- Free high-yield bank account
- Free online rent collection
- Same-day ACH payments
- Check writing
- Generous cash back on qualified debit card spend
- Up to $3 million in FDIC insurance
- 50 states lease creation and e-sign
- Provides Zillow-sourced market values automatically
- No rental property listing capabilities
- No partial rent payment options
Related: 6 Ways to Invest in Apartment Buildings [w/Minimal Effort!]
Reporting It All to the IRS
Make sure you report all monthly rental income and expenses to the IRS. They will want a full accounting of your rental income and expenses related to all real estate assets (including any vacant property you own).
Get into the habit of keeping separate records of income and expenses for each rental property. This will help save time when you’re completing your Schedule E paperwork, which we talk a bit about below.
Related: Best Tax Software
Schedule E, Form 1040
Generally, independent landlords who operate rental properties can report all of their pertinent information to the IRS using Schedule E, Form 1040. Such items include:
- rental income (include all amounts in gross income received for rent)
- operational expenses (deduction)
- maintenance costs and repairs (deduction)
- capital expenses (depending on the nature of expenses, can be depreciated or deductible expenses)
- property value (for depreciation)
- legal fees (deduction)
- property taxes (deduction)
- property manager fees (deduction)
- mortgage interest (deduction)
Rental property owners with more than three rental properties should complete and attach as many Schedules E forms as needed to list the properties and rental expenses.
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