Whether you find rental property taxes and Schedule E tax forms simple or difficult, errors do happen and some of them can be costly. Sometimes fixing them can be difficult and time consuming. Paying interest and penalties is not any fun either. Here are some errors to avoid.
1. Depreciation Errors.
Depreciation is often viewed as complicated. There are multiple parts of the tax code that address or that relate to depreciation. Some common depreciation errors include -not depreciating when required/allowed, using the wrong basis, including land in rental property depreciation basis (land cannot be depreciated), and choosing the wrong recovery period/useful life. The list of errors possible in this area is long and you can read more on depreciation errors here.
2. Not submitting 1099 information returns when required.
Generally, if you pay one person $600 or more during a calendar year for work related to your rental property, and they aren’t working on behalf of a corporation, you should file a 1099-NEC with the IRS and provide one to the person. There are exceptions as well as additional requirements. You can find details here.
3. Not claiming travel expenses.
You can deduct ordinary and necessary travel expenses related to rental activities. Travel for maintenance, inspections, and collection of rent are examples that would usually qualify. Emphasis on the ordinary and necessary. Flying from CA to Virginia on a private jet each month to collect rent would probably not be considered ordinary and necessary. For auto travel there are rules regarding claiming standard mileage vs actual expenses. When combining business (or rental activity) travel with pleasure or personal travel there are rules on what can be claimed and what cannot. More information can be found in IRS Pub 463.
4. Poor Recordkeeping
You know you aren’t doing a good job keeping tax related records if you find yourself scrambling to find all the information needed to complete a tax return. Keeping rental income and spending separated from personal one by using separate accounts makes record keeping easier.
One of the biggest areas of poor record keeping is the tracking of mileage for vehicle travel expenses. A good practice is to record the mileage every January 1st for any vehicle that may be used for rental activity purposes. And then to track all mileage. Apps can be used to help with tracking and the IRS provides an example of a mileage log in Pub 463 page 26.
Good recordkeeping isn’t just about the tax prep. It helps when you are audited as well. All expenses should have proof (almost always). Adequate evidence. Documentary evidence will ordinarily be considered adequate if it shows the amount, date, place, and essential character of the expense. Being able to show that it was actually paid is good too.
5. Not filing state tax returns when required.
This one is common for military landlords. Often servicemembers and their spouses are used to just filing one state return with their state of legal residence under the Servicemembers Civil Relief Act (SCRA) which includes the Military Spouse Residency Relief Act (MSRRA). But some income can be and is sourced to the duty station state or other states. Rental property income can generate a filing requirement in the state in which the rental property is located. In many cases even if there is no clear filing requirement it can be wise to file anyway.