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Top 4 Mistakes in Rental Property Bookkeeping

After a long tax season, I'm finally ready to get back into writing articles. This year taught me a lot with seeing what various clients do for their bookkeeping (or lack thereof). In this article, I’ll be discussing the most common mistakes I saw during this year and what you can do to prevent them. 

Incorrect Mortgage Interest

The amount for mortgage interest should tie out to the government form 1098 that you receive from your mortgage company. Many investors provided the incorrect amount and this needed to be revised once it got to me. Considering this is likely one of the top two expenses investors have, this is one to be sure to get right. 

What you can do: At the end of the year when you get the tax form 1098, ensure your bookkeeping system matches this amount. If you have multiple 1098s, add them together and ensure they match to your bookkeeping system. 

Property Taxes in the Year of Purchase

If you purchase a property in Illinois, you typically get a closing credit on your real estate taxes. You cannot deduct the property taxes until the amount you pay exceeds this amount. For instance, if you purchase a property on 1/1/21 and receive $7,000 at closing, you must pay $7,001 to even deduct $1 of property taxes. See the “Property Taxes” section of this article for a more detailed example. Most investors had the property tax amount paid during the year and this is incorrect. 

What you can do: If you bought a property during the year, look at the closing statement to see how much credit you received. Then, at the end of the year, see how much was paid per the county website. If the amount paid during the year exceeds the credit received, then you are able to deduct only the amount in excess of the credit. If the amount paid is less than the credit, you will have a credit carryforward for the following year. 

Escrow Payments Do Not Equal Your Deduction

The amount that you pay into escrow is NOT deductible. The amount paid FROM escrow is deductible. Typically, the items paid from escrow are property taxes and insurance. Please note that the property taxes paid from escrow should equal the amount per the county website. 

Example: During the year, an investor paid $10,000 into escrow. This amount is not deductible. However, $8,000 in property taxes were paid from escrow during the year and $2,000 was paid for insurance. These amounts are deductible. 

What you can do: During the year, look at each monthly statement from your mortgage company. Then, take the amount paid from escrow for property taxes and insurance.  

Rehabs

This is a very nuanced area and I will do my best to keep it simple. If you are buying a property and immediately rehabbing with no tenants, you must capitalize (depreciate) all items put into service during that time because you simply have a property that’s not available for rent. Additionally, you have to capitalize any interest paid during the rehab period as well. The rehab period ends when you obtain a certificate of occupancy or first advertise for rent. 

What you can do: 

Keep track of all costs during the rehab and after the rehab. Divide these up between appliances, furniture and fixtures, land improvements, and building improvements. After keeping track of the expenses, talk with your CPA. There are too many areas where this can get complicated. It is well worth the extra time and money to go through. For my clients, I provide a simple rehab calculator that will aid in our discussion.  

Conclusion

By not tracking the above items properly, you may be missing out on deductions to or overstating the deductions that you should actually be receiving. Either way, if you can get a grasp on getting these amounts correct, you will be getting the vast majority of the deductions you are entitled to. 

If you have questions on your real estate tax strategy, you can reach me (Aaron Zimmerman) at aaronz@thethinkers.com

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