Accidental landlords are those that find themselves in a situation where they are forced to rent out their home. Fundamentally, they cannot pay the mortgage but are unable to sell, so must either be foreclosed, sell cheaply at a significant loss or rent it out and move to cheaper housing. If you have found yourself in this situation, you must pay tax on your rental income, but there may also be some other tax implications that you can work to your benefit.
Your cash flow improves because you are paying out less, and your rental income at least pays the original mortgage. You can sell your home later when prices rise, and meantime your credit record is unaffected. How does this affect your income tax situation?
Like all accidental landlords, you are taxed on your rental income. You must declare that when you file your taxes for that year. To do that you will have to include an IRS Schedule E Form 1040 (Supplemental Income and Loss from Rental Real Estate).
Accidental Landlords: Income Tax Deductions
However, accidental landlords can also make some deductions against their tax liability, and you do that on the same form. All expenses involved in making the real estate suitable for rental can be claimed. Examples of deductible expenses are:
• Mortgage interest on the property.
• Property tax.
• Repairs and maintenance.
• Landscaping fees.
• Cost of any furniture or appliances included in the rental.
• Household insurance.
• HOA fees – you can deduct these because you are renting rather than residing in the property.
• Any Letting Agency fees.
• Any other expenses you incur through renting the house.
Deduct the total of these expenses from your rental income for the year. The result will be the net profit or loss you gain or incur through renting the property. If your expenses exceed the total rental you are paid, then you will have made a loss for that year.
The depreciation of your rented real estate could be a high sum, and will help significantly in reducing your accidental landlord income tax liability. It is based upon the price you paid for the property and not on its current value. You are advised to seek the help of a professional tax or mortgage adviser to calculate the depreciation.
Fundamentally, you add any capital improvements made to your home to the initial sum paid when you purchased it. This figure is known as your taxable basis. Then deduct the value of the land from that to get the building value which you then divide by 27.5 years to arrive at the depreciation figure. You then add that to the Schedule E as an expense, just as you do the others, some of which are listed above.
It is quite common for the expenses of accidental landlords to exceed their rental income. In this case you will be able to reduce your overall income tax liability, and could get a reasonable tax refund depending on the amount by which your rental expenses including depreciation exceed your rental income. This does not necessarily mean you are making a loss on the deal, because depreciation will be a large part of that difference.
Be Aware Of. . .
Using the property yourself in the same year you changed it to rental use. This will negate your depreciation claim for the entire year.
Renting only part of the property. In this case you can claim only that proportion of the total space that is rented. So if you rent out only one room at 350 sq. ft. in a property of 2200 sq. ft. then you can claim only 15.9% of the expenses, including only 15.9% of the depreciation.
The upshot is that accidental landlords should keep receipts for every cent they have spent on your property while preparing it for rental and maintaining it after renting it out. Be fully aware of all expenses and also of the amount of depreciation you are entitled to claim. Use the experience and knowledge of a real estate professional to help you with this and with completing the Schedule E form correctly.
Accidental landlords can save a great deal on their income tax liability if they are fully aware of their entitlements and how to avoid negating any of them. Make full use of your allowable tax deductions, but be certain you can prove your entitlement. Becoming an accidental landlord can help you keep your home, avoid a drop in credit rating and help you to reduce your income tax liability. If you need help in achieving this then get it. Don’t trust to luck!