An investment property’s operating expenses are the costs you incur to maintain the property and rent it out to tenants. Operating expenses reduce an investment property’s net operating income, or profit. Operating expenses and certain non-operating expenses reduce the income on which you must pay income tax. You can deduct an investment property’s operating expenses from its gross income to determine the net operating income the property generated during a period. Higher net operating income makes a property more valuable.
Determine the potential rental income your property would have generated in a year if it was fully occupied. Also, determine the other income your property generated during the year, such as laundry machine income, and the money you lost to vacancies and uncollectible rents. For example, assume your property would have generated $500,000 in potential annual rental income if it was fully occupied. Also, assume you generated $10,000 in other income during the year and lost $20,000 to vacancies and uncollectible rents.
Subtract the amount lost to vacancies and collections from the potential rental income. Add other income to your result to determine your effective gross income, which is income before deducting operating expenses. In this example, subtract $20,000 in vacancies and collections from $500,000 to get $480,000. Add $10,000 in other income to $480,000 to get $490,000 in effective gross income.
Determine from your records the operating expenses you incurred while running the property during the year, including utilities, property taxes, insurance, employee salaries, management fees, marketing, maintenance and supplies. In this example, assume you spent $5,000 in utilities, $40,000 in property taxes, $20,000 in insurance, $60,000 in salaries, $35,000 in management fees, $10,000 in marketing, $15,000 in maintenance and $10,000 in supplies.
Add together the operating expenses to determine total operating expenses. In this example, add $5,000, $40,000, $20,000, $60,000, $35,000, $10,000, $15,000 and $10,000 to get $195,000 in total operating expenses.
Deduct total operating expenses from total income to determine your net operating income or net operating loss. A positive result represents net operating income, while a negative result represents a net operating loss. Concluding the example, subtract $195,000 from $490,000 to get $295,000 in net operating income. This means the property generated $295,000 in profit during the year.
- Consult an accountant to determine any non-operating expenses, such as depreciation and mortgage interest, that you can deduct to determine the investment property’s taxable income.
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