The tax implications of an investment property can be intimidating to a new landlord. It is helpful to know what income must be reported to the IRS, what is taxable, and the deductions you are entitled to as a rental property owner. According to the IRS, you must include all money you receive for rent as part of your gross income for the year.
The IRS classifies rental income as "any payment you receive for the use or occupation of property." Even if you are paid advance rent prior to the time period it covers, you must report the income in the year it is received. If the tenant pays for any expenses for the property, such as repairs or replacement of an appliance, you must count it as rental income received. However, a security deposit is not included in your total income. If you keep a portion for repairs, cleaning, painting and so forth, you will report the amount kept as income for that year.
There are deductible expenses that can lessen the tax implications of an investment property, and reduce the amount of rental income on which you are required to pay taxes. In general, the costs you incur to prepare the investment property for tenants, manage the property and maintain it, are deductible expenses, even during periods of vacancy. Ordinary and necessary expenses include repairs, pest control, utilities, maintenance, depreciation, management fees, mortgage loan interest, property taxes and supplies.
Selling Investment Property
Whether you sell a property that is your primary residence or an investment property, you need to know the basis of the property for tax purposes. Typically, the basis of a home is the price you paid for it, in addition to the cost of all capital improvements made to the home while you owned it. For an investment property, you are claiming capital improvements on your tax return, along with depreciation costs. The tax implications of selling an investment property start with a reduction in the basis for your home for the amount of total depreciation you claimed on all previous tax returns. If you have rented the property for a significant time period, or it has appreciated in value, a reduction in the basis could substantially lower your profits from the sale of the property.
Foreign Investment Property
If you own investment property in another country, you are still required to report your worldwide income on your personal income tax returns. Your rental income is reported at the current exchange rate, as are deductible expenses. You are still permitted to take all the ordinary and necessary expenses of managing and maintaining the property, including depreciation. The tax implications of a foreign investment property mean you may be paying income taxes in the country where the property is located as well. However, you can claim the foreign income taxes as a deduction or a credit against your income tax liability in the U.S.
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