Tracking your rental property expenses not only gives you clarity into the health and profits of your business, but it’s also crucial for protecting yourself in the case of an IRS audit. As a landlord, you should track all your rental expenses, including maintenance costs, utility expenses like electricity, pest control, advertising fees, and others. Below are some tips for tracking your expenses like a pro.
Organize Your Essential Documents
There is a list of documents that you need to have readily available for reference purposes when tracking your rental property expenses. These documents have vital information that your tax professional or potentially the IRS will need to reference.
For instance, make sure that you have leases from past and current tenants that date back several years. Any legal documents, court hearings, or evictions notices and fines should also be kept safe, along with copies of all communication with your tenants. You should also keep all property deeds, receipts for things like labor and materials, invoices for services, and utility bills.
Other important documents to keep handy include insurance policies, mortgage information, and your federal and state tax returns for the past five years.
Track Deductible Expenses
In addition to tracking rental property expenses, you should also keep track of the expenses that you can write off in tax deductions. An expense must be considered an operating expense to be fully deductible in one year. Operating expenses are ongoing, everyday business expenses. To qualify for immediate deduction, they must be ordinary and necessary, current, directly related to your rental activity, and reasonable in amount.
You can write off legal and accounting fees, advertising and office expenses, maintenance and repair costs, and if you employ workers that receive a salary, you should make sure that you track their payments, taxes withheld, and any benefits you pay out to them. Each of these are deductible operating expenses.
Be Prepared for IRS Audits
It’s common to hear about real estate investors getting audited by the IRS for shady write offs or unclear tax filings. Although it’s tempting to write off anything you think may possibly be deductible, it’s more important that you don’t break the law.
When checking for audits, the IRS mainly looks at four major categories of rental property expenses.
Meals and Entertainment
When writing off expenses for meals and entertainment, it’s best to create a policy that you and your employees can easily remember and follow. A good rule of thumb is to only reimburse meals and entertainment if the business conducted happened before, during, or after the meal. If you have a concrete policy that is written down and followed, it looks much better if the IRS decides to audit you.
Also, as with all deductions, make sure you have clear documentation proving that it is in fact a business expense.
Substantial and Vague Expenses
If you have large expenses that are not specifically categorized, the IRS may take a closer look and could choose to audit you in order to investigate further. Sometimes taxpayers take liberties with deductions by writing off expenses under vague names like “administrative expenses” or “other expenses”.
You should try and give as much explanation as you can and break down your expenses into smaller, more descriptive chunks. For example, instead of writing off $4,000 of “other expenses”, you can break it into $2,000 for continuing education, $1,000 for phone, and $1,000 for technology and software.
Donating to Charity
The IRS expects you to be able to donate around 3-5% of your annual income to charity. If you claim donations as much more than that, the IRS may start paying closer attention to your business’ finances and deductions.
If you choose to donate to charity, especially if you donate a substantial amount each year, make sure you keep detailed records to prove that the money is going where you say it is.
One of the perks of being a landlord is being able to deduct out-of-town travel expenses. You can deduct things like lodging, gas, and parking fees when you’re travelling for business. However, don’t abuse this privilege. Deducting five-star hotels, first-class flights, or other gratuitous expenses can lead to an audit. Make sure you’re keeping receipts and other evidence that your travel expenses are for business and not leisure or a vacation.
The best way to track your rental property expenses is through property management software like Innago. When you choose software that works best for you and your business, you can gather data, pull reports, and analyze your expense reports without worrying about silly mistakes or inconsistencies. Automating your record tracking is a great way to save time and money. Do yourself a favor and track your rental expenses digitally.
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