Taxes are always a little daunting, but landlords have a heavier lift than the typical tax payer - and it can be especially distressing for new landlords. To help ease the burden of this fiscal responsibility, here are a few things to keep in mind.
As a landlord, you can use one of two accounting methods: cash-basis method or accrual method. It's important to understand which method you use so you can accurately report income and expenses on your taxes. The cash-basis method tracks when money comes into or goes out of your accounts, no matter when that money is technically due or technically owed. The accrual method, on the other hand, tracks when something is technically earned or technically owed, not when it actually changes hands.
To solidify these concepts, here are some examples. Let's say you have a tenant who generally pays rent on time, but they miss a month. In the cash-basis method, you’d only count income when this tenant pays you. With the accrual method, you count income when you earn it - so the first of each month if that’s your rent due date. For expenses, let’s say you have a vendor who takes care of the grounds on your property, and for one reason or another, you didn’t pay the company on the due date. With the cash-basis method, you wouldn’t count this as an expense until you actually pay the company, while with the accrual method, you would count this on your books as soon as the company earned the money and no matter when you pay it.
Both accounting methods have pros and cons: The accrual method helps you see clearly the long-term health of your business while the cash-basis method is simpler and does a better job of tracking actual cash flow, ultimately helping you better see where your business is in the moment. Most small business owners use the cash-basis method for these reasons as well as for the money advantages that come along with this method of accounting. Technically, if you're an "active participant" in your business - and all DIY landlords are - the Internal Revenue Service (IRS) considers you a small business, which means you can use up to $25,000 in losses toward your normal income, making the cash-basis method a win.
Related: Real Estate Accounting: Property Financial Management Tips You Need To Know
Constructive Receipt of Income
If you use the cash-basis method, to stay on the good side of the IRS, you’ll want to follow the constructive receipt concept. It’s a small but important construct that factors into how you need to report your rental income and expenses. This accounting principle means you must count money as an expense when your creditor has control over it and money as income when you have control over it - even if the money technically hasn’t shown up in or been removed from your account. For instance, if your tenant writes you a check at the end of December and you don’t cash it until the beginning of January, you must count it as income in December because that’s when you received control over the money. On the other hand, if a check bounces, you didn’t technically have control over the money, so you should not count the money as received.
How you report security deposits depends on how you treat them. Some landlords intend to use security deposits as a tenant’s last month of rent. If this applies to you, count the security deposit as income when the tenant gives you the money. If you plan to return your tenant’s security deposit after he or she completes the rental term, don’t count it as income when you receive it. On the other hand, if you have to keep part or all of the security deposit because your tenant causes damage to your property, count it as income when you take the money from the security deposit.
Related: Top 4 Small Landlords Success Accounting Tips: Guide to Rental Property Accounting
From the information we’ve shared above, you can see why it’s essential to keep detailed accounting records. When accounting specifics are recorded properly and up to date, it eases the stress of filing taxes. Taking advantage of TenantCloud’s accounting software can make your life much easier at tax time and beyond. Not only does it help you keep track of all your accounting records for ease filing, it also lets you switch between the cash-basis and accrual methods for easy viewing all year long—allowing you the benefits of using both methods: understanding the long-term health of your business and how your business is doing right now.
What other tips do you have for landlords at tax time? Leave a comment below. We’d love to hear your thoughts or pieces of advice on this topic.