Updated for Tax Year 2014

OVERVIEW

If you own investment or rental property, TurboTax will help you with deductions, depreciation, and getting your biggest possible refund.

When you rent out a house or condo, taxes can be a headache.

Consider this scenario:

After buying a condo and living in it for several years, Sue meets Steve, marries him and moves into his house. Because the rental market in their area is improving, they decide that instead of selling Sue's condo, they could make some money by holding on to it and renting it out. But as first-time landlords, they don't know whether they need to report the rent they receive on their tax return and, if so, whether any of the money they spent to get the condo ready to rent is deductible.

Does this story sound familiar? If so, you're not alone. Taxpayers in similar circumstances find themselves asking these questions:

When do I owe taxes on rental income?

In general, you must report all income on the return for the year you actually receive it. even though it may be credited to your tenant for a different year.

You must also report income that you have received constructively. This means the funds are available to you even if you haven't taken possession of them. For example, if your renters place their January 2015 checks in your mailbox late in December of 2014, you cannot avoid reporting the rent as 2014 income by simply leaving the checks in your mailbox until January 2015.

What can I deduct?

Costs you incur to place the property in service, manage it and maintain it generally are deductible. Even if your rental property is temporarily vacant, the expenses are still deductible while the property is vacant and held out for rent.

Deductible expenses include, but are not limited to:

• Advertising
• Cleaning and maintenance
• Commissions
• Depreciation
• Homeowner association dues and condo fees
• Insurance premiums
• Interest expense
• Local property taxes
• Management fees
• Pest control
• Professional fees
• Rental of equipment
• Rents you paid to others
• Repairs
• Supplies
• Trash removal fees
• Travel expenses
• Utilities
• Yard maintenance

All expenses you deduct must be ordinary and necessary, and not extravagant.

You can deduct the cost of travel to your rental property, if the primary purpose of the trip is to check on the property or perform tasks related to renting the property. If you mix business with pleasure, though, you're required to allocate the travel costs between deductible business expenses and nondeductible personal costs. Be careful not to cheat yourself on the breakdown.

Consider this example: John, who lives in North Carolina and loves to ski, owns a rental condo in Park City, Utah, which he visits each January to get the place ready for that season's tenants. His travel expenses are deductible if, for example, the primary purpose of his trip is to clean and paint the unit. Let's say that during a five-day visit to the condo, John spends three days cleaning and painting and two days skiing. Some advisors would say he gets to deduct 60 percent of his travel costs, since 60 percent of the time was spent on the business of tending to his rental unit.

But following that advice would be a costly mistake. Since the primary purpose of the trip is business, the full cost of transportation to and from Park City is deductible. It's the costs while there that need to be allocated between business and personal expenses. Sixty percent of the cost of a rental car would be deductible, for example, plus the cost of meals during the three business days. (Another tax law restriction limits your deduction for business meals to 50% of the cost.)

Now, if John spent three days skiing and two days working on the condo, none of his travel expenses would be deductible, although the direct costs of working on the condo (the cost of paint and cleaning supplies, etc.) would be deductible rental expenses.

Keep good records. To deduct any expense, you must be able to document the write-off. So hold on to all receipts, cancelled checks and bank statements.

Can I deduct improvements and repairs?

Ah, there's a big difference between improvements and repairs. The cost of property improvements generally must be capitalized and depreciated over several years (by following IRS depreciation tables) rather than deducted in the year paid. By contrast, the cost of repairs can be written off in the year you pay them.

Improvements are actions that materially add to the value of the property or substantially prolong its life. Examples include:

• Additions to the structure
• Adding a swimming pool
• Installing a water filtration system
• Modernizing a kitchen
• Installing insulation

Repairs, on the other hand, just keep the property in good operating condition. Examples of repairs:

• Painting
• Repairing appliances
• Fixing leaks
• Replacing broken windows or doors

How do I calculate depreciation?

Depreciation is a deduction taken over several years. You generally depreciate the cost of business property that has a useful life of more than a year, but gradually wears out, or loses its value due to wear and tear, weather damage, etc. To figure out the depreciation on your rental property:

1. Determine your cost or other tax basis for the property.
2. Allocate that cost to the different types of property included in your rental (such as land, buildings, so on).
3. Calculate depreciation for each property type based on the methods, rates and useful lives specified by the IRS.

1. Determine Your Cost Basis

Your cost basis in the property is generally the amount that you paid for the property (your acquisition cost plus any expenses), including any money you borrowed to buy the place.

If you are converting your property from personal use to rental use, your tax basis in the property is calculated differently. Your basis is the lower of these two:

• Your acquisition cost
• The fair market value at the time of conversion from personal to rental use

If the property was given to you or if you inherited it, or if you traded another property for the current property, there are special rules for determining your tax basis in your rental property. If you were given the property, for example, your basis is generally the same as the basis of the generous soul who gave it to you; if you inherited it, your basis is generally the property's value on the day the previous owner died. Special rules apply to property inherited from people who died in 2010.) Consult IRS Publication 551: Basis of Assets for more information about these situations.

2. Allocate the Cost by Type of Property

After determining the cost or other tax basis for the rental property as a whole, you must allocate the basis amount among the various types of property you're renting. When we speak of types of property, we refer to certain components of your rental, such as the land, the building itself, any furniture or appliances you provide with the rental, etc.

If your rental is a condo or other property that shares property within a community, you're deemed to own a portion of that property. A portion of the land and a portion of the purchase price must be allocated to the land on which the building sits.

Why this effort to divide your tax basis between property types? They are each depreciated using different rules and different lives.

3. Calculate the Depreciation for Each Type of Property

Here are the most common divisions of tax basis for a rental property, followed by explanations of the different methods of depreciation that generally apply:

Type of Property