There are many tax deductions available for landlords and property investors, but also very specific ways you must file your taxes. Because of the complex nature of real estate investor taxes, you should keep thorough and detailed records of all important documents, income and expenses throughout the year. Knowing what records to keep for tax purposes can turn filing your taxes from a nightmare and potentially costly experience, into a relatively stress-free one.
Keeping detailed records is beneficial for many reasons:
- It will make it much easier to file your taxes.
- Having everything recorded will help keep you from missing out on any deductions, thereby saving you money.
- It will help you make sure you are filing accurate claims. Instead of guessing, “I think I paid that contractor $1,000,” by quickly pulling up a spreadsheet, you will know you paid him $850 on July 17.
- In case you are audited or the IRS has any questions about items on your tax return, you will have the proof to back up your claim. If you do not have this documentation, you will find yourself spending time and money trying to find the proof. Worse, if you are not able to come up with a receipt, your claim will not be honored and you may even have to pay additional taxes and penalties.
What Records Should I Keep Track Of?
The short answer is you should keep track of everything! The IRS is notorious for auditing small businesses, especially those that show a loss in consecutive years. Additionally, many IRS agents do not understand the tax nuances that apply to real estate investors, making them more likely to question your filing. You will need to have proof if the IRS questions any of your items or even in the everyday course of business if someone tries to question a payment. You will need to keep permanent records and short-term records.
1. Permanent Records
These are documents that you will want to keep indefinitely.What are some examples of permanent records?
These are documents that will be relevant and valuable to you well beyond the current tax year, such as:
- All tenant leases.
- Any sort of legal documents- fines, inspection reports, court appearances.
- Any type of permit you have taken out on the property.
- Anything you would depreciate- such as property or improvements.
- If you have your company incorporated as an LLC, LP, S Corporation or other, you will want to keep all records pertaining to this.
- Insurance policies.
- Loan documents- such as mortgages.
- Past years’ taxes.
- Property title/deed.
2. Short Term Records
By short term, I am not referring to a couple of months. You will want to keep any documents you deem important enough to claim on your taxes for a minimum of five years. How long after that depends on your comfort level. This will help you in case you are ever audited or sued.What are some examples of short term records?
Anything that counts as income or an expense for the given tax year, such as:
- Advertising costs for your business or property.
- Entertainment expenses- such as dinners or lunches for current or potential customers.
- Interest paid on mortgage and any credit cards for business use.
- Legal/professional fees- for accountants, lawyers, insurance agents, Realtors.
- Office expenses- internet, second phone line for business, office supplies, home office deduction if you have a home office used solely for business.
- Rent received.
- Repairs performed.
- Security deposits received.- When a tenant's lease ends, if you keep part of the security deposit, you must record it as income. If you keep some of it to pay for repairs, the money you spend on the repair is considered an expense, which you can deduct on your taxes.
- Travel expenses for business- such as miles driven for rental activities.
- Utilities paid.
- Wages paid to employees or independent contractors.
How Should I Keep Track of My Records?
You should keep a digital copy (computer) and a hard copy (paper) of all of your records.
1. Digital Copy
You will want to use a spreadsheet or a program such as Quicken Rental Property Manager to keep track of your income and expenses. You should do this as soon as the income comes in or the expense occurs. You will want to include as much detailed information as possible: the date, time, who it was paid to or who paid you, nature of the income or expense, and the amount. You can even include how it was paid or incurred (cash, check number, credit card, money order, etc.).
The level of detail will depend on the software you use or create. Some programs will link directly to your bank accounts and will record your income and expenses for you. Even if you choose a less expensive program, or keep your records on personal spreadsheets, you should still set up separate records for each property, for each type of expense, and for separate types of income. The point is to record as much information as you can at the time of the transaction, so that you can easily create financial reports in the future.
You should always back them up on cd, on an external hard drive and even with a paper copy. They should be printed out at the end of every month and/or the end of the year.
2. Hard Copy
You will want to make sure you have a paper copy of your most important documents. If possible, you will want to store them in some sort of fire retardant filing system or safe deposit box. If you are unable to find one large enough for all your files, you will want to keep the most important ones, such as the titles to the property in this box. Categorize everything by year and then alphabetically sort the files so they are easy to find.