“One penny may seem to you a very insignificant thing, but it is the small seed from which fortunes spring.”
Those words were spoken over 100 years ago by Orison Swett Marden, the founder of SUCCESS magazine who is often considered the father of modern-day inspirational talks. His words still make sense to this very day, especially for real estate investors seeking to maximize returns.
In this article, we’ll explain how rental property owners can track every expense down to the last penny, find more tax deductions, and save time and increase financial performance by adopting modern software that automatically keeps track of rental property expenses.
To get you started, we’ve also included a free rental property expense tracking spreadsheet that you can download and customize. It’s not as efficient as today’s software platforms, but it will help you learn the ropes and develop a basic understanding of what to track.
Key Takeaways
- The IRS broadly defines rental property expenses as operating expenses, repairs, and depreciation.
- The benefits of accurately tracking the expenses of a rental property include calculating profit or loss, monitoring for unexpected costs, claiming tax deductions to which you are entitled, and creating a digital “paper” trail for audit purposes.
- Manual spreadsheets, off-the-shelf accounting software, or online platforms purpose-built for real estate investors are three main ways to keep track of rental property expenses.
- Financial metrics such as NOI, cap rate, operating expense ratio, and cash on cash return all depend on accurately recording and analyzing rental property expenses.
What are Rental Property Expenses?
IRS Topic No. 414 Rental Income and Expenses lists several types of rental property expenses an investor may deduct from the total rental income received:
- Operating expenses necessary for the operation of the rental property, including amounts paid to property managers, landscaping and utilities, property taxes and insurance, and mortgage interest expense.
- Repair costs needed to keep the property in good working condition, excluding capital expense work that adds longer-term value to the property, such as a new roof or air conditioning system.
- Depreciation expense allowances for exhaustion, and wear and tear of the property.
Income is recorded when it is received, and expenses are booked when bills are actually paid. As a quick aside, a refundable security deposit expected to be returned to a tenant is neither income nor an expense. Instead, when the deposit is received, it is recorded on the balance sheet as a liability because the security deposit is meant to eventually be returned.
Free Rental Property Expense Tracking Spreadsheet
To save you the time and hassle of building an expense tracker from scratch, we’ve put together a simple expense tracking spreadsheet below that you can download and use (in both Excel and Google Sheets formats).
Note that these spreadsheet templates are displayed in View Only format. You’ll need to make a copy or download them to edit.
Click here to download the complete rental property expense tracker (Excel)
Click here to download the complete rental property expense tracker (Google Sheets)
An Alternative Way to Track Your Property Expenses (on Autopilot)
Even with just one rental property, it’s easy to lose track of deductions that could decrease taxable net income. Or even worse, accidentally double-book an expense only to have it discovered during a tax audit.
That’s why investors looking for cost-effective rental property software often opt for Stessa, which offers both free and paid subscription plans. It’s used by both novice and sophisticated investors to track income and expenses and make informed decisions about their property portfolios.
Stessa was designed by rental property owners for rental property owners to provide a comprehensive suite of features and services to rental property owners. To set up an account with Stessa, simply enter the property address, connect bank, credit card, and mortgage company accounts, and then enter tenant and leasing data to start running real-time financial performance reports from the owner dashboard. Once entered, income and expenses are automatically updated, tracked, and categorized for easy reporting and tax preparation, and a downloadable “paper” trail is created.
Rental Property Expenses to Track
Rental property expenses are typically recorded in an itemized list or report format, along with a paper trail that provides back up to prove that every expense claimed is true and correct. Although tracking rental property expenses can be time consuming, it’s well worth the effort.
There are four good reasons why experienced real estate investors keep accurate rental property expense records including:
- Monitoring profit or loss of a rental property
- Providing data to strategize on ways to maximize profits
- Allowing investors to claim tax deductions to which they are entitled
- Createing a paper trail for audit purposes
Main Types of Rental Property Expenses
Some of the most common expenses of a rental property include:
- Accounting and legal expenses
- Advertising and marketing costs
- Depreciation
- Insurance
- Maintenance expenses
- Mortgage interest
- Property management fees
- Property taxes
- Repairs
- Travel expenses (in some circumstances)
- Utilities paid by the landlord
Other Documents and Rental Property Records
Some rental property expenses can be claimed in the year they are paid, while capital expenses are depreciated over the useful life of the improvement. Rental property documents and records also provide backup to verify the expenses claimed by an investor are accurate. Some examples include:
- The settlement statement from when the property was purchased helps determine which costs to expense and those that must be added to the property basis.
- Mortgage documents, property tax assessments, and Form 1098 provided at year-end are used to verify the annual mortgage interest deduction.
- Federal and state tax returns for the past several years document income and expenses claimed.
- Back-up copies of use or sales tax returns show the amount of rental tax collected and remitted to the city and state.
- Property management agreement(s) confirm the new account start-up and monthly management fees.
- Initial invoices from utility companies document refundable security deposits collected to begin service.
- Documents showing expenses incurred to lease a vacant property, including application fees, security deposits collected, leasing commissions paid, and legal costs of evicting a tenant.
- Copies of current and previous tenant leases and correspondence going back three to five years provide a record of lease terms and maintenance issues.
- Bank statement records for checking and savings accounts set up for a rental property business.
Normal rental property operating expenses, along with documents and records, generate a tremendous amount of paperwork. The more paperwork there is, the easier it is for something to get lost.
That’s why Stessa provides free cloud-based document storage to real estate investors. The system was designed from the ground up with reliability in mind, using multiple layers of security to keep data safe and secure.
Rental Property Depreciation
Residential rental property is depreciated over a period of 27.5 years to compensate the investor for property exhaustion, and wear and tear. The annual depreciation expense is deducted from pre tax net income to reduce the amount of personal taxes a real estate investor pays.
Here’s a quick look at how rental property depreciation works.
Assume a home is purchased for $240,000. After subtracting the value of the lot (because land doesn’t depreciate) and adding in capitalized closing costs such as owner’s title insurance, the cost basis used for depreciation is $220,000.
By dividing $220,000 by 27.5 years, an investor may claim an annual depreciation expense of $8,000 until the property is sold or the depreciation allowance is gone. While this example is simple enough, the challenge is that the cost basis of a rental property changes over time.
Each year a depreciation deduction is claimed, the basis decreases. When a capitalized expense like new carpeting or new roof is installed in the rental property, the cost basis increases and so does the annual depreciation amount.
However, when you make a capital expenditure, it’s important to note that this doesn’t just automatically increase the total cost basis and the annual depreciation amount. The impact on your depreciation schedule can vary depending on the nature of the expenditure.
For example, if the useful life of the new asset (like carpeting or appliances) is shorter than 27.5 years, it will have a different depreciation schedule. This means that it may not simply be added to your original depreciation schedule. It’s essential for rental property owners to understand these subtleties to accurately track their expenses and depreciation.
Reporting Rental Property Expenses to the IRS
Income and expenses on a rental property are reported to the IRS using two main forms:
- IRS Form 1040 or Form 1040-SR, Schedule E, Part I is used to report income, expenses, and rental property depreciation. Additional Schedule Es can be attached if an investor has more than three rental properties.
- Form 4562 is used to calculate and report the amount of rental property depreciation shown on Schedule E.
Investors can fill out these forms by hand and file them with the IRS, use advanced online tax preparation software, or engage a qualified CPA. Stessa’s Tax Package reporting feature can also help investors with overall organization and tax readiness.
Tax resources for Stessa customers include a suite of tax resources created in partnership with The Real Estate CPA, a firm that specializes in real estate investment, and helpful how-to articles and videos.
Why Accurate Expenses Matter
By accurately keeping track of expenses, a real estate investor can identify potential opportunities to increase revenues and the overall return on investment (ROI) of a rental property. Some different types of expenses and how they are calculated are provided below.
- Operating expense ratio (OER) is calculated by dividing operating expenses (excluding any non-cash depreciation expense) by operating income to measure how well expenses are being controlled.
- Net operating income (NOI) is calculated by subtracting operating expenses (excluding the mortgage) from income.
- Capitalization rate measures the return or profit on investment by dividing NOI by current property value.
- Internal rate of return (IRR) estimates the interest or return received for each dollar invested in a rental property over the entire holding period.
- Cash flow is the money remaining at the end of each month after the rent has been collected and all of the bills (including any mortgages) have been paid.
- Cash-on-cash return compares the net amount of cash received each year to the amount of cash currently invested.
Of course, keeping accurate track of every expense helps a real estate investor to claim every possible tax deduction to keep more profit instead of unnecessarily giving money to the government.
