9 Real Estate Tax Reporting Mistakes to Avoid

As a landlord, accurately reporting your rental income to the IRS is a legal requirement and crucial for avoiding costly penalties and fines. However, even with the best intentions, mistakes can happen when reporting rental usage.

In the following sections, we'll explore some of the most common and less well-known errors landlords make when reporting rental income and expenses to the IRS and the consequences of these mistakes. 

We'll also discuss how property management tools can help landlords avoid misreporting rental income, allowing them to comply with regulations and keep their rental business on track. 

So whether you're a seasoned landlord or just getting started, read on to discover how you can avoid getting into hot water with the IRS over rental income reporting mistakes.

Common tax mistakes for real estate investors

Accuracy is vital when dealing with the IRS, but when it comes to reporting rental income for income tax purposes, mistakes can happen. Being aware of some of the most common tax errors among real estate investors will help you avoid any unwanted trouble. 

1. Failure to report all rental income received

One of the most common mistakes landlords make is underreporting their rental income. This can happen when landlords only report rent from select tenants, overlook short-term rentals, or omit income from other sources such as parking or storage. To avoid this mistake, landlords must remember that all rental income, regardless of origin or amount, must be reported on their tax returns.

Real estate investors must create a system for maintaining detailed records of all rental income and accurately reporting it to the IRS to avoid potential issues.

2. Failing to keep accurate records of rental expenses and income

Without proper record-keeping throughout the year, accurately calculating rental income and expenses for your taxes will be difficult. This last-minute scramble can lead to underreporting of rental income, over-claiming of deductions, and other tax errors that can result in penalties and fines. 

To avoid these issues, use bookkeeping tools or, at minimum, a spreadsheet to keep detailed records of all rental income received and expenses incurred throughout the year. This includes receipts, invoices, and other relevant documents that can help you accurately track and report rental activity to the IRS. 

By keeping accurate records, you can ensure you claim all eligible deductions and report rental income correctly while complying with IRS regulations.

3. Improperly claiming deductions for rental expenses

Landlords should capitalize on all eligible real estate deductions to reduce your tax liability. Common deductions include property taxes (up to $10,000), mortgage interest, repair and maintenance costs, and other expenses associated with owning and operating a rental property. 

However, some landlords may overclaim expenses, claim expenses that are not eligible, or fail to provide adequate documentation to support their deductions.

To avoid these issues, it's essential to keep accurate records of all rental expenses, know which expenses are eligible for a deduction, and consult with a tax professional to ensure that you're claiming deductions correctly and within the guidelines set by the IRS.

4. Misreporting rental property depreciation

Depreciation is a tax deduction that enables landlords to deduct the rental property's deterioration over time. Some landlords make mistakes while reporting rental property depreciation by over-depreciating or under-depreciating their assets. Additionally, they may fail to recapture depreciation upon the property's sale or misclassify it as residential or commercial.

To avoid these issues, it's important to accurately calculate and report rental property depreciation on your tax return, keep detailed records of their value, and consult with a tax professional to ensure that you're claiming depreciation correctly and within the guidelines set by the IRS. 

5. Improperly designating a property as personal use

When a real estate investor uses their property for both personal and rental purposes, they may accidentally misclassify it on their tax return. This often occurs when the landlord occupies the premises for part of the year and rents it for the remainder. 

Generally, if a property is rented out for any length of time, it's considered a rental asset for tax purposes. Therefore, it's essential to report all rental income received, even if the property is also used for personal purposes. Learn more about the tax implications of fair rental days versus personal use days.  

Less common real estate tax reporting mistakes

Now that we've covered the most common rental income reporting mistakes that landlords make, let's delve into some of the lesser-known or frequently forgotten errors that can still result in serious consequences with the IRS.

1. Failure to report income from short-term rentals

Short-term rentals have become increasingly popular in recent years, but many landlords may not realize that they must report all rental income received from these types of rentals on their tax returns. This includes income from services like Airbnb, VRBO, or other short-term rental platforms. 

2. Claiming a rental loss for a property that was not available for rent

Landlords can only claim a rental loss for a property available for rent during the tax year. Claiming a rental loss for an unavailable property could lead to legal issues, penalties, and fines if discovered by the IRS.

To avoid these complications, landlords should make an effort to ensure their property is available for rent and take steps to market it to potential tenants. This includes setting a reasonable rent amount, making necessary repairs or improvements, and advertising the property to potential renters.

3. Failing to report security deposits correctly

Security deposits help landlords protect their rental property from any potential damage caused by tenants. These deposits are not considered rental income when received, but landlords must handle them carefully to avoid any tax-related issues.

When a security deposit is received, it must be appropriately documented and accounted for in the landlord's financial records. If a landlord keeps all or part of a security deposit after the tenant moves out, that amount must be reported as income on their tax return for the year it was kept.

On the other hand, if a security deposit is returned to the tenant, it is not considered rental income and should not be reported to the IRS. In this case, the security deposit is simply a refund of the tenant's money and is not taxable income for the landlord.

4. Incorrectly reporting repairs vs. improvements

Landlords must distinguish between repairs and improvements when reporting rental expenses to the IRS. 

Repairs, such as fixing a leaky faucet or patching a hole in the wall, are deductible in the year they are made. Improvements, such as adding a new roof or renovating a bathroom, must be depreciated over time. Landlords who mistakenly categorize improvements as repairs may not take the proper deductions or may claim improper deductions, which can result in penalties and additional taxes owed.

Consequences of misreporting rental income to the IRS

Following are the consequences of misreporting your rental income or expenses to the IRS:

• Penalties and fines: If a landlord underreports rental income or overreports rental expenses, they may be subject to penalties and fines from the IRS. Landlords who fail to report rental income may face penalties, such as an accuracy-related penalty of 20% of the understated amount or a civil fraud penalty equal to 75% of any federal tax not paid due to fraud. If there is a substantial understatement, the accuracy-related penalty is 20% of the portion of the underpayment of tax that was understated on the return. 
• Interest charges on unpaid taxes: In addition to penalties and fines, landlords may be subject to interest charges on unpaid taxes due to misreporting rental usage to the IRS. If taxes, penalties, additions to tax, or interest are not paid by the due date, the IRS imposes underpayment interest. The failure-to-pay penalty is capped at 25% of the unpaid taxes and accumulates until the underlying tax is paid in full. 
• Increased risk of an IRS audit: The IRS may audit a landlord's tax return if they suspect the landlord has underreported income or over-reported expenses. Audits are tedious and expensive, requiring real estate investors to provide detailed documentation and explanations for all items on their tax return. 
• Legal consequences: Misreporting rental income may be considered tax evasion, which is a felony criminal offense. If a landlord is found guilty of tax evasion, they may be subject to fines, penalties, and even imprisonment. 

It's crucial for landlords to take rental income reporting seriously and to ensure that all income and expenses are reported accurately and honestly.

Avoiding tax mistakes with property management tools 

Managing rental assets can be daunting, especially for landlords who own multiple properties. Luckily, property management tools like Azibo can simplify the process. 

Azibo’s accounting solution is designed for landlords and comes with all the tags, metrics, and reports you’ll need to stay organized and compliant. By using Azibo tracking rental income and expenses in real-time and generating detailed financial reports, real estate investors can monitor the financial health of their business and identify areas for improvement. 

Azibo is free for rental property owners. And along with accounting, Azibo offers free solutions for rent collection, tenant screening, insurance, and other property management tools.

Final wrap-up of real estate tax reporting mistakes

Accurately reporting rental usage to the IRS is crucial for landlords to avoid penalties and legal consequences. 

While keeping track of all the necessary information can be challenging, property management solutions like Azibo can simplify the process. With tools for accounting, income and expense tracking, and rent collection, landlords can minimize the risk of misreporting and save valuable time. 

By taking the necessary steps to accurately report rental income and expenses and seeking professional help when needed, landlords can avoid missteps and ensure that their rental business complies with IRS requirements.