Those of us with rental income have a few decisions to make at tax time. Whether your 2015 taxes are done or not, let’s go over the decisions while they’re topical. Next year you can remember what we said and improve your process.
Rental Income Tax Decision 1: DIY or Hire
It’s easier than ever to do your own taxes. See below for some choices, including a free one we really recommend. Doing your own taxes takes time. If you’re just starting out, your time may not be worth very much. Doing your own taxes may therefore be cheaper. Also, by doing them yourself you will learn how taxes are supposed to be done. This will help you supervise an accountant down the road.
But you can also hire an accountant. Accountants know about the most recent tax changes. The latest changes are easily missed online unless you google specifically for them, for instance, “Tax changes for 2015”. Otherwise you can easily find outdated blog articles without realizing they’re outdated.
Accountants also can help with an audit, and can help you focus on things you’d rather be doing. The downside to accountants can be the expense, especially if you have multiple legal entities.
Some accountants are also borderline crooks. They will be too aggressive with expenses, or ensure the property runs at a loss, or do other unethical things thinking you're intentionally looking the other way. Make sure you know who you're hiring and what they're doing.
Every year, before the year ends (for instance, in November), you should estimate how your taxes will shake out. If there are many changes from previous years, or if you’re worried you’re missing deductions and credits, hire an accountant then and there.
In November there's still time to change things if necessary. You can watch how the accountant handles your situation and learn what they do. You can then decide to stick with them for the following year, or to pull your taxes back to DIY once more.
Rental Income Tax Decision 2: DIY Filing Options
If you’re still considering doing taxes yourself, make sure you’re using the best option.
Federally, individuals can now use FreeFileFillableForms.com. These are electronic copies of all the forms. You can add “Schedule E” for rental income as easily as you can order a copy from the IRS. When you’ve entered your numbers, you can click “Do the math” and it will calculate the numbers for you.
FreeFileFillableForms.com doesn’t always add all the numbers. You still need to understand the process. But it saves enormous time compared to pen and paper. And as the name says, it’s free.
You can also use H&R Block Online or TurboTax for rental income. Be very careful. These “interview” style products do not follow the tax forms exactly.
H&R Block, for instance, requires you to reenter your entire depreciation table in excruciating detail every year for each property, item by item. The IRS doesn’t require this. You only need to file form 4562 to document new property placed into service, and Schedule E takes the total. You do need to keep a depreciation table at home, but you don’t have to type it in every year.
For Massachusetts taxes, H&R Block and TurboTax often lack support for Schedule LP Lead Paint credits. Usually credits will pay out. So if you owe zero, and you have a $100 credit, the IRS sends you $100. The LP credit will only “zero out” your Massachusetts balance, but it will never be paid out. It’s only useful if you have a Massachusetts tax obligation, and the online interview forms don’t handle this. You will need to call to get someone at TurboTax or H&R Block to take this credit.
Massachusetts has a new electronic filing system for business, Mass Tax Connect, and it’s quite a bit better than the old website. This new website is rolling out for individuals starting with tax year 2016.
Rental Income Tax Decision 3: Expensing vs Capitalizing (aka Repairs vs Improvements)
The IRS wants to make sure you pay taxes now. It’s usually in your interest to pay taxes later. That’s the heart of the argument about repairs vs improvements. You do have a choice here, but first, the reminder of how this works:
A repair can be expensed fully in the year it was paid for (cash accounting) or when the obligation to pay was created (accrual). A repair returns something to its old state.
An improvement must be capitalized and expensed a little each year according to its depreciable life. Computers, for instance, have a life of five years. Residential roofs have a life of 27.5 years. An improvement makes something newer or better than it was before.
The same job could become either a repair or an improvement. Putting epoxy into a cracked cast iron pipe would be a repair (you can expense the epoxy). Replacing the pipe with new cast would be an improvement (you must depreciate the new pipe).
Rental income recipients do have some choice for smaller items. If replacing the cast iron pipe is a small amount of money, you’re allowed to adopt a written policy stating that you will expense it even though it should be capitalized. Be careful: you must defend this during an audit. The larger your business, the more may be expected of your depreciation tables.
Also, note: a bunch of tiny improvements made at the same time must be added together and depreciated as a unit, called a “general plan of improvement”.
So those are the rental income tax decisions DIY landlords get to make. We hope this helped. Good luck!