Did you know that over 10.6 million Americans declared rental income in their tax filings, according to the IRS? That’s a lot of landlords navigating the complexities of tax season. Unfortunately, even small errors can lead to costly fines—up to 20% of underpaid taxes, reports the National Association of Tax Professionals.

But don’t worry! With a little preparation, you can sidestep common pitfalls and save yourself the stress of audits. For example, individual landlords reported an average rental income of $34,217 in 2018, with $23,679 in deductible expenses. Understanding the ins and outs of rental property taxes can make a significant difference to your bottom line. Let’s break it down together!

1. Misclassifying Income or Expenses

When it comes to rental property taxes, even landlords can stumble into some common pitfalls. Many landlords accidentally misclassify or forget to report certain types of income.

For example, if you collect a $1,000 security deposit and keep $200 for repairs at the end of the lease, that $200 needs to be reported as income. It’s easy to forget, but the IRS is keeping an eye out for these details.

This is where things can get really tricky. The most common mistake here is confusing repairs with improvements. Mixing these up can lead to big errors on your tax return. For instance, if you claim a $10,000 kitchen remodel as a repair instead of an improvement, you’re deducting too much too soon, which could raise red flags with the IRS.

Another common mistake is trying to deduct personal expenses. Remember, only expenses directly related to your rental property are deductible. That means if you’re staying at your rental for a weekend getaway, you can’t deduct your personal meals or entertainment as rental expenses.

2. Failing to Report All Rental Income

When it comes to rental income, one of the biggest mistakes landlords make is failing to report everything accurately. First, many landlords forget to report informal or non-traditional income. This includes:

• Cash payments that aren’t officially recorded
• Security deposits that are kept as income
• Late fees or other penalties collected from tenants
• Pet fees or deposits
• Payments received for canceled leases

For example, if you let a tenant pay $100 in cash for a late fee and don’t record it, that’s still taxable income. Overlooking these small amounts can add up to a significant sum over time.

Let’s say your tenant is a painter and repaints a room in exchange for $500 off their rent. You still need to report that $500 as income, even though no money changed hands.

3. Incorrectly Depreciating Rental Property

One of the most common mistakes landlords make is starting depreciation on the wrong date. For example, if you buy a fixer-upper in June but don’t have it ready for tenants until August, your depreciation clock starts ticking in August, not June. This might seem like a small detail, but it can make a big difference on your tax return.

Another biggie is forgetting to depreciate improvements. Let’s say you add a fancy new roof or renovate the kitchen after you’ve bought the place. These aren’t just repairs – they’re improvements that should be depreciated separately.

For instance, if you spend $10,000 on a new roof, you can’t just deduct that all at once. You need to depreciate it over time, just like the rest of the building. Here’s a quick rundown of other depreciation mistakes to watch out for:

• Trying to depreciate the land value
• Using the wrong depreciation method

Forgetting to stop depreciation when you sell or convert the property to personal use

Remember, depreciation is like a slow-motion deduction that happens over many years. It might seem complicated, but getting it right can lead to significant tax savings over time. If you’re ever unsure about how to handle depreciation for your rental property, it’s worth chatting with a tax pro.

4. Missing Deductions and Credits

This is a big one. Don’t forget that you can deduct the interest you pay on your rental property mortgage. It’s easy to overlook, especially if you have multiple properties, but it can add up to a significant amount. Many landlords forget about this one, but it’s a mistake that can cost you.

If you use a property management company, their fees are fully deductible. This includes costs for finding tenants, collecting rent, and managing day-to-day operations. If you’ve made your rental property more energy-efficient, you might be eligible for tax credits. Think solar panels, energy-efficient windows, or improved insulation. Many landlords don’t realize these improvements can lead to tax benefits.

The big mistake here is simply not knowing about these deductions or forgetting to claim them. It’s like leaving free money on the table. For example, if you spent $5,000 on new energy-efficient windows but forgot to claim the credit, you could be missing out on hundreds of dollars in tax savings.

5. Inaccurate Record-Keeping

Let’s talk about a mistake that can really come back to bite landlords: not keeping accurate records. It might seem like a hassle to track every little expense and income, but trust me, it’s a lot less painful than facing the consequences of poor record-keeping. Here’s what can go wrong:

• You might miss out on deductions because you forgot about expenses you can’t prove
• During an audit, you could end up paying more taxes if you can’t back up your claims
• You might struggle to accurately report your rental income, which can raise red flags with the IRS

Those $20 trips to the hardware store for light bulbs and air filters add up. Without receipts, you can’t claim these deductions. Using your rental property account to buy groceries? That’s a no-no. It makes it hard to separate what’s deductible and what’s not.

Cash payments without proper documentation can look suspicious to the IRS. Let’s say you spent $5,000 on a new HVAC system for your rental property. That’s a big, deductible expense. But if you can’t find the receipt or invoice during an audit, the IRS might disallow the deduction. Suddenly, you’re on the hook for taxes on that $5,000 you thought you could write off.

6. Misunderstanding Pass-Through Tax Deductions

The common mistake that many landlords make is misunderstanding pass-through tax deductions, especially the Qualified Business Income (QBI) deduction. What is the QBI deduction? It’s a tax break that allows eligible landlords to deduct up to 20% of their qualified business income. But here’s where people often go wrong:

• Assuming all rental income automatically qualifies: This is a big mistake. Not all rental activities are eligible for the QBI deduction.
• Misunderstanding the “trade or business” requirement: Many landlords don’t realize that their rental activities need to rise to the level of a “trade or business” to qualify.
• Overlooking the safe harbor rules: The IRS provides a “safe harbor” for rental real estate enterprises.

Some landlords forget about these limits and overestimate their deduction. The QBI deduction is available for “pass-through” entities like sole proprietorships, partnerships, and S corporations. But some landlords mistakenly think they need to set up a specific type of entity to qualify. In reality, even a simple Schedule E filing can potentially qualify.

Another pitfall is failing to aggregate properties correctly. If you own multiple properties, you might be able to treat them as a single enterprise for the QBI deduction. But if you don’t do this consistently or correctly, you could miss out on the deduction entirely.

7. Overlooking Estimated Tax Payments

When it comes to rental property taxes, one of the biggest mistakes landlords make is overlooking estimated tax payments. First, many landlords don’t realize they need to make quarterly estimated tax payments at all. If you expect to owe at least $1,000 in taxes on your rental income, you’re generally required to make these payments.

Unlike employees who have taxes withheld from each paycheck, landlords need to proactively pay taxes throughout the year. Estimating your tax liability can be tricky, especially if your rental income fluctuates. The due dates for estimated taxes (April 15, June 15, September 15, and January 15) don’t align perfectly with calendar quarters, which confuses some people.

To calculate your estimated taxes, you need to estimate your expected rental income, deductible expenses, and resulting tax liability for the year. The IRS provides a worksheet in Form 1040-ES to help with this.

A common error is underestimating your tax liability. Remember, you generally need to pay either 90% of your current year’s tax liability or 100% of your previous year’s tax liability (110% if you’re a high-income taxpayer), whichever is smaller.

8. Failing to Separate Personal and Business Finances

It might seem convenient to use one bank account for everything, but trust me, this can lead to a world of headaches come tax time. So, what’s the big deal? Here are some of the ways landlords often go wrong:

• Using personal accounts for rental income and expenses
• Paying for rental expenses with personal funds
• Using a personal credit card for rental expenses
• Not keeping separate records

When you file your taxes, you need to report all your rental income and expenses accurately. If your finances are all jumbled together, you’re more likely to make mistakes. You might under report your income (which can get you in trouble with the IRS) or miss out on deductions (which means you’re paying more taxes than you need to).

Plus, if you ever get audited (and let’s hope you don’t), having your rental finances mixed with your personal ones can make the process much more stressful and time-consuming. The IRS might end up scrutinizing your personal expenses too, which nobody wants.

9. Ignoring Local and State Tax Requirements

When it comes to rental property taxes, one of the biggest mistakes landlords make is ignoring or overlooking local and state tax requirements. It’s easy to focus solely on federal taxes, but failing to consider state and local taxes can lead to serious issues.

You’ve been diligently paying your federal taxes, but you didn’t realize that your city recently passed an ordinance requiring short-term rental owners to collect a 5% occupancy tax from tenants. If you’ve been renting out your property for a year without collecting this tax, you could be on the hook for thousands of dollars in back taxes and penalties.

10. Overlooking Tax Software or Professional Help

Navigating rental property taxes is complex. Failing to use property management software or consult a tax professional can increase the likelihood of mistakes.

Final Thoughts

Managing rental property taxes doesn’t have to be overwhelming. Avoiding these common mistakes can save you time, money, and stress.

Ready to simplify your rental property management and stay on top of your tax obligations? Discover how our property management software can streamline your operations and maximize your rental investment.