Becoming A Landlord
As a landlord, you have the opportunity to earn income from your real estate investment. While your property ideally appreciates in value over time, the income that you receive in the form of rent can supplement (or in certain cases even match or exceed) your monthly mortgage payment, allowing you to build equity in a home you might otherwise not be able to afford. Some of the rental income can also be used for repairs and maintenance, enabling you to keep the home in good condition. In addition to rental income, you may also be eligible for several tax benefits:
- Depreciation – Residential rental properties (houses and apartments) typically use the 27.5 year modified accelerated cost recovery system (MACRS) schedule for depreciation. This means that you can deduct depreciation costs over 27.5 years. Note that you cannot depreciate the cost of land since land does not wear out, become obsolete or get used up. For example, assume the structure on your rental property was worth $250,000 when you purchased it. You would be able to claim tax deductions of $9,091 ($250,000 / 27.5) each year for depreciation. Note also that the cost of improvements (such as adding a deck or new roof) is recovered through depreciation.
- Home office expenses – If you use a portion of your home for your rental property business, you may be able to take a home office deduction. In general, in order to claim a business deduction for your home, you must use part of your home exclusively and regularly for your business. Expenses related that that portion of your home (such as office furniture, a percentage of utilities, etc.) may be deductible. Certain items may be depreciated.
- Insurance – You may be able to deduct the cost of insuring your rental property. Most types of landlord insurance – including building, content, fire and liability – may be deductible. A standard homeowner’s policy typically does not cover tenant-related losses, so it is important to purchase the correct insurance to protect your investment.
- Property management – You may be able to deduct the ordinary and necessary expenses for conserving, maintaining and managing your rental property. “Ordinary” expenses are common expenses that are generally accepted in the rental property business; “necessary” expenses include advertising, insurance, interest, maintenance, taxes and utilities.
- Mortgage interest – If you took out a loan to purchase or improve your rental property, you may be able to deduct the full amount of interest. You may also be able to deduct the cost of property tax.
- Property repair and maintenance expenses – Any repair and maintenance expenses that are considered necessary and reasonable are tax deductible. Repairs keep your property in good condition, but do not add value to the property. (Improvements, however, can add value to your property, and these costs must be depreciated.) For example, expenses related to painting, plumbing and roof repairs would be tax deductible, along with any other expenses necessary for keeping the rental property in habitable condition.
- Professional real estate services – You may be able to deduct costs associated with professional services related to your rental property, including fees paid to accountants, property managers and real estate lawyers.
- Tax-free exchange – You may be able to avoid paying taxes when you sell your rental property if you reinvest the proceeds from the sale in another property. This is called “switching” or a “tax-free exchange.”
- Travel expenses – Your travel expenses related to the management of your rental property may be deductible. For example, you can deduct mileage for driving to your rental property to meet with tenants, driving to the hardware shop to purchase necessary repair materials or driving to your property to collect rent payments.
It should be noted that the IRS can disallow any expense that you claim if you cannot show documentary evidence to support the expense. For example, if you deduct expenses related to replacing a broken door but you have no receipts to substantiate the expense, the IRS may not allow you to claim the expense and you could be subject to additional taxes and/or penalties. It is vital that you keep accurate, well-organized records. Because many receipts fade over time, it is a good idea to photocopy receipts and then staple the copy and the original together (you can also scan the receipts for a digital copy).
Obligations and Responsibilities
As you can see, there are many financial advantages involved in renting your property, from mortgage interest to home office deductions. It is important to consider, however, the realities and responsibilities of being a landlord, including the following:
- Financial obligations – You will be responsible for meeting your monthly mortgage payment even if the property is vacant or if your tenant has not paid his or her rent. In addition, you may have unexpected expenses related to your tenants, such as legal expenses incurred as a result of a problem tenant.
- Legal obligations – As a landlord (and business owner), you will have to understand and abide by the laws, rules and regulations pertaining to rental housing. You are legally responsible for complying with all local, state and federal laws even if you don’t understand them (i.e., ignorance is no excuse). If you are not in compliance, you can be fined, and lawsuits and complaints can be filed against you.
- Round-the-clock availability – If your tenant calls at 3 o’clock in the morning because the dishwasher flooded the entire first floor, you will have to be available to deal with the emergency. If you will not be available to respond to tenant problems, you must designate someone to act and make decisions on your behalf.
- Maintaining habitability – As a landlord, you are required to maintain a safe and habitable property for your tenants. You can be held liable for tenant or visitor injuries that result from unsafe conditions. To maintain habitability, you must do the following (at a minimum):
Keep all common areas, such as hallways and stairways, in a safe and clean condition.
Make sure structural elements (e.g., floors, walls, stairs, roofs) are safe and intact.
Ensure that electrical; plumbing; heating, ventilation and air conditioning (HVAC); and sanitary systems are property maintained.
Make sure tenants have access to running water, hot water and heat in reasonable amounts at reasonable times.
Provide trash containers and arrange for trash removal.
Manage known environmental toxins including lead paint, dust and asbestos.
Exterminate rodents and other vermin infestations.
Your local laws may call for additional requirements regarding “habitability.” It is important to know about and be incompliance with all federal, state and local laws.
Being a landlord is not as simple as collecting rent. It is important to consider the time, obligations and responsibilities involved before making the decision to become a landlord. You might want to ask yourself the following questions before making a decision:
- Am I prepared to share my home with other people?
- Can I learn about and comply with local, state and federal rules, laws and regulations?
- Am I willing to spend money to make sure the rental property complies with lead paint and asbestos regulations?
- Can I afford the time and costs associated with maintaining a “habitable” rental property?
- Am I ready to accept the risks associated with being a landlord?
- Can I make the mortgage payment even if the property is vacant or my tenant hasn’t paid his or her rent?
- Do I want to be available 24 hours a day to respond to tenant complaints and emergencies?
- Am I able to maintain detailed and accurate records?
- Am I willing to pay for professional services, including those of attorneys and tax accountants?
Being a landlord can be a full-time job, depending on your properties and tenants. Even if you are able to fulfill your duties and responsibilities by working part time, it is important to approach your rental property as a business to increase your chances of success and profitability.