How to Track Rental Expenses for Taxes

Track every rental expense against the property it belongs to, keep the receipt, and tag each one with its Schedule E category when you pay it. Do that and most of tax time is adding up columns. The two rules that cause most mistakes: you can't deduct mortgage principal, and you can't deduct an improvement all at once.

What you can deduct

Most landlords report rental income and expenses on Schedule E (Form 1040). The IRS's Publication 527 describes the most common rental expenses, which include advertising, auto and travel, cleaning and maintenance, commissions, insurance, legal and professional fees, management fees, mortgage interest, other interest, repairs, taxes, utilities and depreciation. Ordinary expenses that don't fit a named line go on the "Other" line.

A suggestion: use these as your categories from day one. Recategorizing a year of receipts at tax time is the slow part.

Repairs and improvements are different

This is the line landlords get wrong most often.

• A repair maintains the property. The IRS says you can deduct it if you aren't required to capitalize it, generally in the year you pay for it.
• An improvement betters, restores or adapts the property. You must capitalize it, which means adding the cost to the property's basis and depreciating it, not deducting it in one year.

Publication 527 lists these as improvements: a new roof, new central air or a furnace, a water heater, kitchen modernization, new flooring, fences and decks. So replacing a water heater is generally treated as an improvement, while repairing the one you have usually isn't.

Record each of these separately from your repairs. The IRS advises separating the cost of repairs and improvements, because you need the improvement costs to depreciate the property and later to figure gain or loss when you sell.

The IRS has safe harbors that let you deduct some small purchases outright. The de minimis safe harbor is $2,500 per invoice or item for taxpayers without an applicable financial statement, and you elect it each year by attaching a statement to a timely filed return. The conditions are in the IRS tangible property regulations, so ask your tax preparer before relying on one.

Things that are not rental expenses

• Mortgage principal. Only the interest is deductible.
• Personal use. If you also use the unit yourself, you divide expenses between rental and personal use based on the number of days for each, and other limits can apply. Publication 527, chapter 5, covers it.

One related point: a security deposit you plan to return isn't income when you receive it. If you keep part of it because the tenant broke the lease, you include the amount you keep as income that year. A deposit used as the final month's rent is advance rent, and it's income when you receive it.

A tracking system that works

1. Give every expense a property. Rent and receipts are reported per property, so a pile of unsorted receipts means redoing the work later. For a duplex or a building, track at the unit level and roll up.
2. Capture the receipt when you pay. A photo, a forwarded email or a PDF. Not "I'll find it in March."
3. Tag the category when you record it. Use the Schedule E lines above. Mark improvements as improvements.
4. Keep rental money apart from your own. A separate bank account or card makes it obvious which charges are rental expenses.
5. Review monthly. Ten minutes a month beats a weekend in April. Anything uncategorized gets a category now.
6. Split shared costs the same way every year. A software subscription or a legal fee for several properties needs one method you can explain.

If you use a spreadsheet, give it one row per receipt: date, property, vendor, amount, category, repair or improvement, and a link to the receipt. Resida's expense tracking does the same job from your inbox: forward a receipt and it files it under the right property with a Schedule E category, and keeps the original email. Its expense summary breaks totals down by property and category.

How long to keep the records

The IRS says to keep records for 3 years in the general case, though some situations require longer, and to keep records relating to property until the period of limitations expires for the year you dispose of it. In practice that means improvement receipts stay with you for as long as you own the property, plus the limitations period after you sell it.

This is general information, not tax advice. Your own situation, such as personal use, a short-term rental or a home office, can change what's deductible, so confirm the details with a tax professional.

Sources: IRS Publication 527, Residential Rental Property; Instructions for Schedule E (Form 1040); IRS, "How long should I keep records?"; IRS Notice 2015-82 and the IRS tangible property regulations FAQ.