If you own a rental property, you’re lucky to have one of the most valuable sources of passive income in the world. But, managing your real estate—and turning it into an investment—can get tricky, particularly on the finance side.
Among the many concerns, you’ll need to make sure that you’re reporting the right information to the IRS. Rental property owners benefit from a range of tax deductions, but only if they have the right finance infrastructure in place. “One financial mistake that I see new rental investors make all the time is failing to calculate cash flow accurately” explains Brian Davis, real estate investor, finance writer and co-founder of Spark Rental, an app for landlords to manage their properties.
“They think that expenses start and end with the mortgage payment. Nothing could be further than the truth.”
Brian continues, “Rental expenses include vacancy rate, repairs, maintenance, property management (even if you self-manage), and administrative and travel costs. As a rule of thumb, expect half your rent to go to non-mortgage expenses. This principle is known as the 50 percent rule.”
Despite these challenges, rental properties have the potential to deliver stable returns in the form of predictable cash flow. Demand for short-term and long-term housing is strong, and Airbnb has become a dominant player in the travel and tourism industry. Rental income is a healthy revenue stream, whether you’re managing a vacation home or long-term residential rental property.
No matter what type of rental property business you run, the following tips can help ensure that you implement an airtight financial plan so that you can understand your operating expenses, manage your cash flow, predict maintenance expenses and get through income tax season, friction-free.
1. Maintain a steady financial cushion
A rental property may start as a pet project or a hobby, but it’s also a capital intensive business. Think about the consequences of needing to invest in an unexpected repair.
As a landlord, you’re legally obligated to maintain a high standard of living for your tenants. That means you need to create a clear line of separation between your personal finance and business finance goals. At a minimum, you’ll need:
- A separate bank account
- Access to legal resources
- Access to lines of credit, especially in the event of an unexpected repair
- A schedule to make sure that you’re treating your home like a business and keeping up with scheduled repairs
“The most important step is to make sure that you have three to six months in financial reserves for your rental property,” explains Jerome Myers, founder at Myers Development Group, a real estate consultancy.
“When you can’t make the appropriate investments in the property because you don’t have the capital, you are starting a dangerous cycle that you might not be able to escape.”
As your business grows—perhaps from acquiring and generating rental income from multiple properties—you might be eligible for additional types of loans and funding to make improvements to your home.
“Landlords need a far deeper cash cushion than most people,” elaborates Davis. “They face large expenses that pop up at unexpected times. It’s not enough to merely include expenses like vacancy rate and repairs in your cash flow calculations. You have to actually set aside that money, month in and month out. When those expenses hit, you need the cash ready.”
It’s not just a nice-to-have to be able to guarantee your tenants’ repair requests. It’s the law: as a landlord, you are obligated to maintain habitable, healthy and comfortable living conditions.
2. Consider working with a property management company
You likely have a range of obligations, especially if you own an investment property as real estate.
Perhaps, you have a vacation home or second property that you inherited, purchased several decades ago or bought for the purpose of renting.
One of the challenges that you’ll run into is time. Regardless of whether you’re a full-time real estate investor or a property owner looking to earn some extra income, you need to make sure that you’re paying close attention to what’s happening on the ground.
That’s why you may want to consider working with a property manager. The right consultant or management company can help you with the following:
- Screening tenants
- Collecting rent
- Managing your books
- Maintaining contracts
- Coordinating repairs
- Figuring out the right amount to collect for a security deposit
A property management company can also step in as an intermediary party if you’re facing disputes. Let’s say, for instance, that a tenant causes damage to your home. A neutral third-party can help de-escalate and provide support.
Typically, landlords pay property managers a percentage of monthly rent. This fee is particularly worthwhile for investment property owners who have full-time jobs or busy schedules with multiple ventures. Because the expense is predictable, it will be a part of your cash flow.
“Have a sound structure in place, and get advice and help from experts, when needed,” says Ramya Menon, editor at Bayut, which specializes in real estate listings in the UAE.
“Working hard doesn’t always mean working smart”
Rayma suggests “reaching out to professionals to help with areas that you are not skilled in can save you time and money.”
3. Work with a tax preparer to make sure your books are in order
If you own a rental property in the United States, you should expect to get help with your tax return when it’s time for filing season. That doesn’t mean waiting for the last minute to file—it’s important for business owners of all types to work on their taxes and build relationships with tax assessors all year long.
In addition to working with the IRS at the federal level, you should also understand your obligations at the state, city and county level. Most counties in the United States levy a tax of around 1%-2% on the assessed value of a property—this type of tax is commonly known as an “ad valorem” tax. You need to make sure that you’re saving a portion of your rental income to cover your property taxes.
Your tax preparer can also help you distinguish your taxable income from your total income—this is especially important if you plan to use your rental property for personal use. Working with a professional advisor, you’ll also gain a clearer picture into deductible expenses.
“Fines can be excessive and ruin any profit you may have made.”
That is why Menon advises that “all revenue and expenses should be tracked methodically.” Any error, even a small one, can have a long term impact on your profitability.
Make rental income easy money
Whether you’re a first-time or experienced real estate investor, your rental property has the potential to be a steady and consistent source of supplemental income. Keep your life headache-free by running your operations like a business with its own bank account and financial infrastructure.
Ultimately, your customers are your tenants—you’re held accountable to their needs and legal rights. Healthy finances will help ensure that you run a healthy business that is a sustainable source of long-term passive income, intermittent rental expenses aside.
This article was produced by the Quickbooks Resource Center and syndicated by MediaFeed.org.
Featured Image Credit: DepositPhotos.com.AlertMe