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Tips on Rental Real Estate Income, Deductions and Recordkeeping

If you own rental real estate, you should be aware of your federal tax responsibilities. All rental income must be reported on your tax return, and in general the associated expenses can be deducted from your rental income.

If you are a cash basis taxpayer, you report rental income on your return for the year you receive it, regardless of when it was earned. As a cash basis taxpayer, you generally deduct your rental expenses in the year you pay them.

Below are some tips about tax reporting, record keeping requirements and deductions for rental property to help you avoid mistakes.

What is Considered Rental Income?

You generally must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use or occupation of property.

In addition to amounts you receive as rent payments, there are other amounts that may be rental income and must be reported on your tax return.

Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it.

Security deposits used as a final payment of rent are considered advance rent. Include it in your income when you receive it. Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year.

Payment for canceling a lease occurs if your tenant pays you to cancel a lease. The amount you receive is rent. Include the payment in your income in the year you receive it.

Expenses paid by tenant occur if your tenant pays any of your expenses. You must include them in your rental income. You can deduct the expenses if they are deductible rental expenses.

Property or services received, instead of money, as rent, must be included as the fair market value of the property or services in your rental income. For example, your tenant is a painter and offers to paint your rental property instead of paying rent for two months. If you accept the offer, include in your rental income the amount the tenant would have paid for two months’ worth of rent.

Lease with option to buy occurs if the rental agreement gives your tenant the rights to buy your rental property. The payments you receive under the agreement are generally rental income.

If you own a part interest in rental property, you must report your part of the rental income from the property.

What Deductions Can I Take as an Owner of Rental Property?

If you receive rental income from the rental of a dwelling unit, there are certain rental expenses you may deduct on your tax return—mortgage interest, property tax, operating expenses, depreciation, and repairs.

You can deduct the ordinary and necessary expenses for managing, conserving and maintaining your rental property. Ordinary expenses are those that are common and generally accepted in the business. Necessary expenses are those that are deemed appropriate, such as interest, taxes, advertising, maintenance, utilities and insurance.

You can deduct the cost of repairs that you make to your rental property. A repair keeps your property in good operating condition and does not materially add value to the property.

You can deduct the expenses paid by the tenant if they are deductible rental expenses. When you include the fair market value of the property or services in your rental income, you can deduct that same amount as a rental expense.

You may not deduct the cost of improvements. An improvement adds to the value of your property, prolongs its useful life, or adapts it to new uses. Examples are adding a deck, a new fence or roof. The cost of improvements is recovered through depreciation.

You can recover some or all of your improvements by using Form 4562 to report depreciation beginning in the year your rental property is first placed in service, and beginning in any year you make an improvement or add furnishings. These expenses must be depreciated over the useful life of the property. Only a percentage of these expenses are deductible in the year they are incurred.

How Do I Report Rental Income and Expenses?

If you rent buildings, rooms or apartments, and provide only heat and light, and trash collection, you normally report your rental income and expenses on Form 1040, Schedule E, Part I. List your total income, expenses, and depreciation for each rental property. Be sure to answer the question on line 2. If you have more than three rental properties, complete and attach as many Schedules E as are needed to list the properties. Complete lines 1 and 2 for each property, including the street address for each property. However, fill in the “Totals” column on only one Schedule E. The figures in the “Totals” column on that Schedule E should be the combined totals of all Schedules E.

Sum up your receipts and canceled checks for your repairs. All of these costs are deductible in the year they were incurred. Fill out Schedule E and Form 4562. List the total of your expenses for repairs on Schedule E, line 16. Carry over your depreciation deduction from Form 4562 and list it on line 20. Complete Schedule E and deduct the total of all of your rental expenses from your rental income. If your rental expenses exceed rental income, you may report a loss up to $25,000 on your tax return, limited for adjusted gross incomes above $100,000.

What Records Should I Keep?

Good records will help you monitor the progress of your rental property, prepare your financial statements, keep track of deductible expenses, prepare your tax returns and support items reported on tax returns.

Maintain good records relating to your rental activities, including the rent and the rental repairs. You must be able to document this information if your return is selected for audit.

Keep track of any travel expenses you incur for rental property repairs. Separate receipts for minor repairs like plumbing, fixing a broken door or minor repainting from receipts for capital improvements like adding a new roof, remodeling a kitchen or installing insulation.

You must be able to substantiate certain elements of expenses to deduct them. You generally must have documentary evidence, such as receipts, canceled checks or bills, to support your expenses.

If you are audited and cannot provide evidence to support items reported on your tax returns, you may be subject to additional taxes and penalties. For example, if you cannot substantiate the rental real estate expenses of replacing the door locks, with appropriate records, the IRS may disallow that expense which may mean that you incur additional taxes and penalties.

SEO: Thriving or Diving

In the ever-expanding universe of the internet, it’s getting harder and harder to be seen. Businesses can no longer rely on being seen based on their own merits. Visibility requires strategy, planning, time and effort. Every day, technology affords us new, more interesting, and (most likely) more complicated ways to reach our audience. Leveraging technology to remain competitive is no longer an option. With over ninety percent of online adults utilizing search engines to find information, the need for a strong, visible presence on the web can mean the difference between your business thriving…or diving.

Search Engine Optimization (SEO) is the process of evaluating and editing the structure and relevance of website content—and the code behind it—to achieve the right balance of content, relevance, usability, and authority. The objective of any SEO program is to improve the ranking of your site in an organic search—in other words, to make your website show up at or near the top of the first page when someone searches for the type of product you offer (e.g. if your company offers healthcare QA services, your goal is to appear on PAGE ONE when someone searches for healthcare QA services).

It’s complicated

If you think SEO is complicated, that’s because it is—very. In order for it to work, besides the programming and “search” expertise, you must crunch a tremendous amount of ever-changing data, understand how it correlates to the marketing goals, and consider its implications on the brand. A good optimization program takes input from a team of people within these areas, working together, to find the right balance.

All roads lead to SEO. SEO leads to all roads.

When you create an optimization program, you must first take a careful look at what has been happening “behind” the site. Assuming some fundamental analytics steps have been taken during the design and creation of the website, there should be some basic data available if you know where and how to look for it:

  • How are people finding your site?
  • Where are they going?
  • Where are they coming from?
  • How long are they staying in the site and where do they go?
  • What search terms are they using to find the site?
  • And much, much more.

Then you have to look at your brand, marketing plans and goals:

  • Who are your target demographics?
  • What are the key words used to describe your brand?
  • What are the key words people might use to find you?
  • What does that GAP analysis look like and why?
  • Who are your competitors? What are their page rankings and why?
  • And much, much more.
  • Then, you should create a plan for how to increase optimization. The recommendations are concise and measurable. Some results happen immediately, and some are part of a longer term strategy.

    It never ends

    Unfortunately that’s true, because, as sure as successful companies are optimizing, their competitors are doing the same. It is an organic process that takes an ongoing program based on precise data.

    As I said at the beginning, visibility requires strategy, planning, time and effort. And let’s face it; if you’re not visible, well, you’re invisible. That about says it all.

Sound Business Advice: Know All the Laws Governing Your Marketing (And You Probably Shouldn’t Misrepresent Your Product Either)

Recipe for a lawsuit: mix 99.5% apple, grape and raspberry juices with 0.3% pomegranate juice and 0.2% blueberry juice and call the resulting juice blend “POMEGRANATE BLUEBERRY.” This is what Coca Cola did to find itself embroiled in a false advertising case brought by POM Wonderful.

POM Wonderful makes a pomegranate blueberry juice comprised entirely of pomegranate and blueberry juices and is a direct competitor of Coca Cola. POM Wonderful alleges that Coca Cola is misleading customers about the nature of its juice product, causing POM Wonderful to lose sales to Coca Cola for what POM Wonderful claims is a far different product than advertised. Coca Cola prevailed in the lower courts by arguing that its label had been approved by the FDA. Because the FDA is authorized to regulate juice beverage labeling and has issued extensive regulations governing the content of such labels, the lower courts reasoned that allowing a false advertising suit by a competitor would undercut the FDA’s “expert judgments and authority” on labeling. Essentially, the lower courts decided that the FDA knows best; if it was okay with the label, the label must not be misleading.

The United States Supreme Court disagreed, holding last month that nothing about either false advertising laws or food and drug laws forbids POM Wonderful’s challenge to Coca Cola’s label. Specifically rejecting the proposition that the FDA possessed expertise to regulate advertising that private enterprise lacked, the Court noted that competitors “have detailed knowledge regarding how consumers rely upon certain sales and marketing strategies” and an “awareness of unfair competition practices [that] may be far more immediate and accurate than that of agency rule makers and regulators.”  Therefore, allowing both administrative enforcement through the FDA and private enforcement by competitors “takes advantage of synergies among multiple methods of regulation.”

The erosion of judicial deference to administrative agencies as the sole, or even primary, guardians of marketplaces is hardly sudden. The Supreme Court, in particular, has shown increasing distrust of governmental agencies as all-knowing regulators. Still, the Court’s ruling is significant because it did not concern the typical direct challenge to the correctness of the FDA’s decision. The Court determined rather that the FDA’s decision, even if proper under food labeling laws, did not matter to the question of false advertising. As a result, competitors may now assert false advertising claims in private suits covering a wide variety of untrue and misleading statements that were permitted or even expressly authorized by the government. Combined with another decision from this term expanding competitors’ standing to sue, the scope of false advertising claims has undoubtedly broadened, potentially leading to more litigation.

The impact of the Court’s decision on small business could be significant. Various industries have certain licensing and regulatory requirements. Under the POM Wonderful decision, marketing content that strictly complies with such regulations may constitute false advertising. For example, advertising that a business uses “green” and environmentally-friendly business practices because it meets EPA requirements may nonetheless constitute false advertising if a jury believes that it used such terms misleadingly. Obviously, the goal should always be not to deceive potential customers, but it is not always clear where the line is. The lesson of POM Wonderful is that you cannot rely on the government to identify the line.

It should be noted Coca Cola has not yet been found guilty of false advertising. The Supreme Court only ruled that Coca Cola could be sued by POM Wonderful under false advertising laws despite FDA approval of the label. A jury may still find that the label was not misleading. But I think Coca Cola has a tough position. Regardless of the outcome, the fact that Coca Cola may get squeezed should make businesses consider carefully their marketing choices and not rely on the government to protect them.

When it Comes to Your Cell Phone, What Does Your Right to Privacy Include?

If you are one of the more than 90% of American adults who own a cell phone, consider for a moment what your device contains. Millions of lines of text? Hundreds of personal photographs? Your internet search history? Confidential or proprietary documents attached to your work emails? Even more in salvageable deleted files or the cloud? Finally, ask yourself, would you like to hand all of this information over to the government?

The Fourth Amendment is the part of the Bill of Rights that prohibits unreasonable searches and seizures, and requires any warrant to be judicially sanctioned and supported by probable cause. As such, a law enforcement officer cannot walk into your home or place of business and conduct a search on your computer, or look through your phone records, without a warrant. The United States Supreme Court has held, however, that a warrantless search may be reasonable if it falls within one of a few specific exceptions. One of those exceptions is when a warrantless search is conducted incident to a lawful arrest.

The United States Supreme Court was recently called upon to consider the case of Mr. Riley, who was stopped by the police for a traffic violation. This traffic stop led to an arrest, which led to a search of Mr. Riley’s person without a warrant. At the time, Mr. Riley was carrying his cell phone in his pocket. The police officer seized Mr. Riley’s phone and over the next few hours, the phone was searched. Based in part on information discovered in the phone, Mr. Riley was charged and convicted of a serious crime.

In a ruling applauded by privacy experts, the United States Supreme Court reversed Mr. Riley’s conviction. In Riley v. California, the Court ruled that the police generally may not, without a warrant, search digital information on a cell phone seized from an individual who has been arrested. The unanimous Court noted that “[c]ell phones differ in both a quantitative and qualitative sense from other objects that might be carried on an arrestee’s person…Before cell phones, a search of a person was limited by physical realities and generally constituted a narrow intrusion on privacy.”

Following Riley, it appears United States citizens have a reasonable expectation of privacy with regard to what is put into their cell phones. But what about what comes out of them? The Rhode Island Supreme Court recently made a distinction in the case of State v. Patino. Certain text messages at issue in that case, from Mr. Patino, were accessed by police from his girlfriend’s phone. The Court opined that a sender of a text message relinquishes control over what becomes of that message on the recipient’s phone. As such, the Court determined that the defendant did not have any reasonable expectation of privacy in his girlfriend’s phone.

It is unlikely that the Founding Fathers could have anticipated the substantially greater individual privacy concerns implicated by mobile devices containing massive amounts of digital information. It is safe to predict that the battle between governmental interests and privacy concerns will continue well into the future, as technology continues to advance and evolve.

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