Rental income can be a lucrative source of passive income for many property owners in California. However, as with any type of income, it’s important to understand how it’s taxed. California has its own set of rules and regulations for taxing rental income. This can be complex and confusing for those who are unfamiliar with the process. Read on to learn more about how rental income is taxed in California.
How is Rental Income Taxed in California?
According to the IRS, rental properties are properties that you own and rent out to tenants for 15 days or more each year. Tax payers have the option to subtract deductions and expenses from the income to calculate the net profit which is taxable.
What is Rental Income?
Rental income is any money you receive for the use or occupation of a property you own. It includes rent payments, security deposits, and any other fees you charge your tenants. It is essential to keep accurate records of your rental income and expenses to ensure you pay the correct amount of taxes.
In the scenario where you receive your rental payment in the form of a service, or “in kind,” the fair market value of the asset of service you receive is considered. For instance, if your tenant offers to paint your rental property in exchange for a month’s rent, and you agree to the arrangement, you consider the amount of rent that the tenant would have paid as your rental income.
Additionally, suppose you are using the rental property partly for personal purposes. In this case, the taxation norms differ. You would then have to segregate the number of days for which the property was used for rental purposes and divide the expenses accordingly.
Since rental income is considered passive income, it is subject to different tax rates than earned income. You must report your rental income on your state tax return (for example, for Californians, on a Form 1040, which is a California Resident Income Tax Return).
Deductible Rental Expenses
Deductible rental expenses are expenses you can claim on your tax return to reduce your taxable rental income. The IRS allows landlords to deduct various expenses associated with owning and maintaining a rental property. Some of the deductible rental expenses in California include:
Mortgage interest – The interest you pay on your mortgage as long as the loan is used to buy, build or improve your rental property.
Property taxes – Property taxes you paid on your rental property.
Insurance – The cost of the insurance premiums you pay to insure your rental property.
Repairs – The cost of repairs necessary to keep your rental property in good condition. You can deduct the cost of materials, supplies, repairs, and maintenance needed to keep your property in good shape.
Utilities – If you pay for utilities for your rental property, such as water, electricity, or gas, you can deduct those expenses.
Property management fees – You can deduct the fees you paid to a property management company to manage your rental property.
However, the cost of improvements cannot be deducted. Improvement costs include the amount expended toward the betterment of the property. You can use Form 4562 to report depreciation and recoup a portion or the entire cost of your property upgrades.
Depreciation is accounting for the wear and tear of your rental property over its useful life. You can claim depreciation as a deductible expense on your tax return. However, it’s recommended you consult a tax professional to ensure you calculate and claim the right depreciation amount.
You can claim for depreciation at the start of the year when your rental property is first utilized. In any subsequent year, you can make an improvement or add furnishings. However, only a fraction of these expenses can be claimed as a deduction in the year they are incurred.
California Short-Term Rental Income Taxation
California imposes a Transient Occupancy Tax (TOT) on short-term rentals, which applies to any rental of a room, home, or other dwelling for 30 consecutive days or less. The TOT is a tax on the total rent charged for the rental, and it is typically collected by the host or the platform facilitating the rental (such as Airbnb or VRBO). This is in addition to the state and federal income taxes on their rental income. Moreover, if a property is rented for 14 days or less, the rental income may be eligible for tax exemption.
It’s important to note that California has specific rules and regulations governing short-term rentals, including requirements for obtaining a permit or license and restrictions on the number of days a property can be rented out each year. Hosts should be aware of these rules and consult with a tax professional to ensure compliance with tax and regulatory requirements.
Reporting Rental Income and Expenses
When you rent out real estate properties such as buildings, rooms, or apartments, you need to report your rental income and expenses on Form 1040 or 1040-SR, Schedule E, Part I. You should list the total income, expenses, and depreciation for each rental property in Schedule E. If you need any clarification on determining the amount of depreciation to enter on line 18 of Form 1040 or 1040-SR, Schedule E, you need to check Form 4562.
If you have more than three rental properties, you must fill out a Schedule E form for each of them. Additionally, if your expenses are higher than your income, you might be able to deduct your loss based on the passive activity loss rules (Form 8582) and the at-risk rules (Form 6198).
It is essential to retain all the necessary documents, such as receipts, canceled checks, or bills relating to your rental activities. Additionally, make sure to monitor any travel expenses you may incur for repairs made to your rental property.
Proper planning and accurate record-keeping will help you minimize your tax liability. Our professionals at Exact Tax Inc. will help ensure you meet all your tax obligations and take advantage of all available deductions. We make your tax process simpler and will ensure that you and your business are financially healthy. Talk to our experts today to learn more.