Your degree of personal involvement depends upon whether you elect to manage the rental property yourself or turn it over (for a fee) to a rental agent or management company.  Even with this decision, there may be questions as to the amount of services performed by the management company – for example, who is responsible for contracting for repair and maintenance work?

If you elect to save the rental agent commission, which could be as high as 20% of the rental charge, you will net greater income but significantly increase your responsibilities and tasks including:

• Advertising,
• Tenant qualification,
• Scheduling,
• Lease execution,
• Collection of rent, security deposit & taxes,
• Record keeping/retention,
• Tax reporting and payment, and
• Property repair and cleaning.

Regardless, you will need to pay real estate taxes, insurance, and possibly association fees and certain utilities.  If your rentals are for periods less than six months, you may have to collect and forward additional taxes to various taxing authorities – e.g., tourist development bureau.  Failure to make all of the appropriate payments to the various agencies could result in a lien placed against the property.  This could result in you being prohibited from renting the property or your rental payment going to the lien holder.

There are many pros and cons for investing in rental properties and being a landlord.  Some of them include:

Pros	Cons
Generates income each month Tax advantages (e.g., depreciation) Increasing rents over time Ability to cover mortgage costs Builds equity	Ties up capital Expenses and upkeep Deadbeat tenants Risk of empty unit(s) Illiquid asset Time commitment & record keeping

One big plus of income-producing properties is that the IRS lets you depreciate the building portion of your property (minus the land) over 27.5 years, which means much of your cash flow will be tax-deferred.  You'll have to recapture that depreciation when you sell, but if you never sell it and you own the property when you die, all that depreciation goes away, your heirs don't have to pay it.

Additional information regarding the depreciation of your rental property is provided later in this section.

A disadvantage is that banks typically require a larger down payment and charge higher interest rates for rental property than they do for owner-occupied homes.

Should you be forced to suddenly sell, you may find yourself in the midst of a down market (as is currently the case across most of the country) and unable to unload your home for a reasonable price, if at all.

At the same time, you may not find renters when you need them, which would force you to cover the mortgage yourself.  The National Association of Realtors suggests that investors in income-producing property keep at least six months worth of reserves on hand in the event they fail to find a renter.

IRS Publication 527 provides information on taxes associated with Residential Rental Property (Including Rental of Vacation Homes).  This publication discusses rental income and expenses (including depreciation) and explains how to report them on your return.  However, like most government documents and especially those associated with tax code, it is complicated and confusing.  Consequently, I’ve provided the following summary of the major tax considerations regarding your rental property.

Rental Income

The following are common types of rental income:

• Regular rent payments
• Advance rent that you receive before the period that it covers
• Your tenants lease cancellation payment
• Any of your expenses paid by the tenant
• Property or services received as rent in lieu of money
• Amount of security deposit kept (if any)

Rental Property Expenses

In most cases, the expenses of renting your property, such as maintenance, insurance, taxes, and interest, can be deducted from your rental income.  If you sometimes use your rental property for personal purposes, you must divide your expenses between rental and personal use.  Also, your rental expense deductions may be limited.  If you own a part interest in rental property, you can deduct expenses you paid according to your percentage of ownership.

Listed below are the most common rental expenses:

• Advertising for prospective tenants
• Auto and travel expenses to collect rental income or manage your property
• Cleaning and maintenance
• Real estate taxes
• Utilities (electric, gas, telephone, water, sewerage, trash collection, cable TV)
• Depreciation (see below)
• Property insurance
• Legal and other professional fees (e.g., tax preparation)
• Property management fees
• Commissions
• Mortgage interest paid to banks, etc.
• Points for prepaid interest (spread over term of loan)
• Rental payments for equipment or property
• Repairs, as differentiated from improvements (see below)

Note that work you do (or have done) on your rental property that does not add much to either the value or the life of the property, but rather keeps the property in good condition, is considered a repair, not an improvement.  The cost of improvements is recovered by taking depreciation.  Following are examples of improvements:

• Additions – bedroom, bathroom, deck, garage, & porch patio
• Lawn & Grounds – landscaping, driveway, walkway, fence, retaining wall, sprinkler system, swimming pool
• Miscellaneous – Storm windows, doors, new roof, central vacuum, wiring upgrades, satellite dish, security system
• Heating & Air Conditioning – a heating system, central air conditioning, furnace, duct work, central humidifier, filtration system
• Plumbing – septic system, water heater, soft water system, filtration system
• Interior Improvements – built-in appliances, kitchen modernization, flooring, wall-to-wall carpeting
• Insulation – attic, walls, floor pipes, duct work

Condominiums have special tax considerations.  With a condominium you also own a share of the common elements, such as land, lobbies, elevators, and service areas.  You and the other condominium owners may pay dues or assessments to a special corporation that is organized to take care of the common elements.  In addition to the expenses listed above, you can deduct any dues or assessments paid for maintenance of the common elements. However, you cannot deduct special assessments for improvements, as these are recovered by taking depreciation.

If you rent buildings, rooms, or apartments, and provide basic services such as heat and light, trash collection, etc., you normally report your rental income and expenses on Schedule E, Part I.  List your total income, expenses, and depreciation for each rental property.  Be sure to enter the number of rental and personal use days.

Limits on Rental Losses

One major advantage with having rental real estate activity is that you may be able to offset any loss against your total income (from all sources).  However, two sets of rules may limit the amount of loss you can deduct:

1. At-risk rules.  These rules are applied first if there is investment in your rental real estate activity for which you are not at risk (meaning that some or all of your possible losses are covered and don’t financially impact you).  This applies only if the real property was placed in service after 1986.

2. Passive activity limits. In most cases, all rental real estate activities (except those meeting the exception for real estate professionals) are considered passive activities, and deductions for the losses may be limited (see below).

You generally cannot offset income, other than passive income, with losses from passive activities.  Nor can you offset taxes on income, other than passive income, with credits resulting from passive activities.  Any excess loss or credit is carried forward to the next tax year.  The exception that allows you to offset losses against non-passive income is “material participation”.

Active (Material) Participation

Generally, you materially participated in a real estate activity for the tax year if you were involved in its operations on a regular, continuous, and substantial basis during the year.  You actively participated if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense.  Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions.

If you or your spouse actively participated in a passive rental real estate activity and your modified adjusted gross income (MAGI) is $100,000 or less ($50,000 or less if married filing separately), you can deduct the following (special allowance) loss:

• $25,000 for single individuals and married individuals filing a joint return for the tax year,
• $12,500 for married individuals who file separate returns for the tax year and lived apart from their spouses at all times during the tax year, and
• $25,000 for a qualifying estate reduced by the special allowance for which the surviving spouse qualified.

If your MAGI is more than $100,000 (more than $50,000 if married filing separately), your special allowance is limited to 50% of the difference between $150,000 ($75,000 if married filing separately) and your MAGI.  If your MAGI is $150,000 or more ($75,000 or more if you are married filing separately), there is no special allowance.

Personal Use of Rental Property

A day of personal use of a dwelling unit is any day that the unit is used by any of the following persons:

1. You or any other person who owns an interest in it, unless you rent it to another owner as his or her main home under a shared equity financing agreement.

2. A member of your family or a member of the family of any other person who owns an interest in it, unless the family member uses the dwelling unit as his or her main home and pays a fair rental price.

3. Anyone under an arrangement that lets you use some other dwelling unit.

4. Anyone at less than a fair rental price.

Any day that you spend working substantially full time repairing and maintaining (not improving) your property is not counted as a day of personal use.

The tax treatment of rental income and expenses for a dwelling unit that you also use for personal purposes depends on whether you use it as a home.  You use a dwelling unit as a home during the tax year if you use it for personal purposes more than the greater of:

1. 14 days, or
2. 10% of the total days it is rented to others at a fair rental price.

If you use the dwelling unit as a home and you rent it fewer than 15 days during the year, that period is not treated as rental activity.  Do not include any of the rent in your income and do not deduct any of the rental expenses.

If you use a dwelling unit for both rental and personal purposes, divide your expenses between the rental use and the personal use based on the number of days used for each purpose.  When dividing your expenses, follow these rules:

• Any day that the unit is rented at a fair rental price is a day of rental use even if you used the unit for personal purposes that day.
• Any day that the unit is available for rent but not actually rented is not a day of rental use.

Following is an example of how expenses are split between personal and rental use on the Schedule E Worksheet:

	Year -->	2024
		Total Exp.	Sch. E
Usage
	Days Rented	350
	Days Personal Use	10
	% Rented		97.22%
Income ($)
	Rents Received		$14,400
			-------------
Expense ($)
	Insurance	280	272
	Cleaning & Maintenance	4,800	4,667
	Management Fees	1,440	1,400
	Mortgage Interest	2,400	2,333
	Supplies	100	97
	Repairs	300	292
	Real Estate Taxes	2,100	2,042
	Utilities	500	486
		-------------	-------------
	Total (Excl. Depreciation)	11,920	11,589
	Cost (Property + Improvements)	140,000
	Depreciation (26 Yr.)		5,385
			-------------
	Total Expense		$16,974
	Income or (loss)		($2,574)

In this example the $2,574 loss could be claimed as a special deduction allowance.  (Note that the allocation of expenses for taxes and interest used the “Days of Use” formula rather than the “Tax Court” formula, either of which is acceptable.) The formulas are:

• Days of Use % = #Days Rented / Total Days Used
• Tax Court % = Days Rented / Days in Year

The Tax Court method may reduce rental expenses and enable you to take additional deductions on Tax Schedule A (Itemized Deductions).