Newbie Question about Calculating Rental Income Tax

[Mike Becher]

I recently purchased my first rental property in August of this year. I created a detailed spreadsheet to track all income & expenses. I'm curious if there are any resources I can be pointed toward to help in calculating income tax on the property. I know it's a vague question, and there might be variables involved that I'm likely unaware of. Not sure where to start with this aspect, so any help is appreciated.

[Michael Plaks]

@Mike Becher

First - basic theory. You take your rental income and subtract all expenses: mortgage interest, property taxes, insurance, maintenance etc. Then you also subtract depreciation which is an accounting gimmick to write off the cost of the property. To very roughly estimate depreciation, take 80% of the property cost and divide it by 30 and then divide by 2 because you bought it mid-year. Warning: you subtract mortgage interest, as opposed to total mortgage payments.

Usually, after subtracting depreciation, you will see a negative number, unless the property is free of mortgage. It means that you have no taxable rental income, and your taxes do not increase. They might even go down, depending on your total income.

Second - tools. Buy Turbotax 2018 software which will soon be available. (Do not use earlier versions, because the tax law has changed substantially, and because you might end up using this software for the actual tax return.) Create a tax return without your rental property which should be straightforward. Write down the total tax. Then add your rental property by answering the Turbotax questions the best you can. See if the total tax has changed and by how much.

Third - hiring a CPA. It's a toss-up. On one hand, there're a lot of mistakes that you could make by doing it in Turbotax. Setting up depreciation incorrectly, deducting the wrong amount of property taxes since you only owned the house for part of the year, deducting something that could not be deducted or not deducting something that could be etc.

A tax accountant would prevent all these errors, but for a price. The cost might outweigh the benefits.

It's really up to  you to decide whether you want to:

1. do it yourself and hope it's good enough
2. become knowledgeable in real estate taxation thru classes or books
3. hire an accountant to do it for you
4. hire an accountant to review what you have done yourself

Once you start growing your real estate portfolio, then a good CPA can become indispensable with proactive tax planning.