Year-End Financial Planning For Rental Property Owners
The end of the year is a hectic time for everyone—including rental property owners. But as December 31 approaches, as a real estate investor, you have an opportunity to prepare for tax season, decrease your tax liability, and set goals for the coming year. Setting aside time to review your books and meet with your tax preparer before year end can pay off, saving you both time and money. We’ve put together an outline to help you review your books—and business—so you can finish this year confidently. Ready? Let’s get started.
Get Your Books in Order
If you’ve let your bookkeeping practices slide a bit, now is the time to catch up your books. Without accurate financial reports, you can’t make informed decisions about your properties or your business. But remember—having your books in order means more than just having all the transactions up to date. Follow these accounting best practices to make sure your books are ready for year end.
• Make sure your business and personal finances are separate.
• Record all transactions, and check for uncategorized items.
• Reconcile your bank, credit card, and loan accounts.
• Review your budget.
And if you need help getting your books together for this year, sign up for REI Hub’s free trial! Our cloud-based accounting software is designed for rental property owners. REI Hub has income and expense tracking, transaction feeds linked to your bank accounts, property- and unit-level reporting, Schedule E exports, fixed asset schedules, and more! And now you can share your REI Hub portfolio access with your business partner, bookkeeper, or tax preparer, making it even easier to keep your books up to date.
When your books are in order, you’ll be well positioned to meet with your tax advisor, decide how to maximize your deductions for this year, and set goals for the coming year.
Meet with Your Tax and Legal Advisors
Although many people only meet with their tax advisor once per year, consider setting up a review meeting in the third or fourth quarter. A review session before the end of the year allows you to discuss adjustments and strategies, potentially lowering your tax liability and getting you ready for the year ahead.
Ask your advisor about these items:
• What are the filing requirements for your business?
This is a great opportunity to review tax requirements for your investment properties. You may need to complete annual filings, like business licenses, registrations, and personal property returns, for states where your business is registered. Your advisor can confirm which forms apply to you and when the filing deadlines are.
• Are there any updates to laws or ordinances that will affect your business or properties?
Laws and ordinances are updated throughout the year, so your legal or tax advisor should inform you about any updates that may affect you.
• Do you qualify as a real estate professional?
The IRS considers most real estate activities as passive income. To deduct your rental income against other active income, your real estate business must qualify as an active activity. Your tax and legal advisors will help you determine if you meet the IRS’s criteria.
• Would a cost-segregation study benefit your business?
Depreciation helps you recover the cost of your rental property and its capital improvements. A cost-segregation study helps you maximize your deductions by front-loading depreciation deductions for certain assets.
• Should you reclassify any of the capital improvements or repair expenses recorded on your books?
If you’re not sure about the IRS guidelines for capital improvements or the de minimis safe harbor rule, your tax preparer can help you properly record and classify those transactions.
• Would your documentation be sufficient if you were audited?
Your records must support your reported income and expenses. If you’re audited, you must be able to substantiate elements of your expenses to prove that they are deductible. Are you confident that your records are sufficient? If not, your advisor can help you identify and correct any weak spots in your books.
Maximize Your Deductions
When your books are in order, you’ll know what your cash flow situation is, where you have room left in your budget, and what funds you have to work with. And your tax advisor may suggest increasing your spending before the end of the year to keep you in a certain tax bracket or decrease your tax liability. If so, consider these options to maximize your deductions for this year.
• Pay bills early.
For cash basis businesses, paying bills early—like paying January’s bills in December—will increase your expenditures for the current year. If those costs are for deductible goods or services, you’ll increase your deductions for this year.
Remember—rental property owners can deduct mortgage interest. Prepaying your January mortgage will increase your interest deduction for this year.
• Record your travel costs.
If you travel for your rental property business, the expenses may be deductible. Remember to record your mileage along with hotel, airfare, and meal costs.
• Purchase fixed assets.
Capital improvements or fixed assets are significant purchases that can affect the value of your property, as well as your annual depreciation deduction. If your property will need a new appliance, roof, or HVAC system soon, consider making the purchase this year.
• Account for disaster, casualty, or theft.
If disaster, casualty, or theft affected your rental property business, the losses may be tax deductible. And if you’ve already received a reimbursement from your insurance company, make sure the payment is recorded correctly.
Set Goals for Next Year
As you review this year’s financial reports, tenants, and property conditions, use that information to decide what your goals for the coming year should be.
• Treat budget variances as red flags.
Review your budget projections for this year and compare them to the actual figures. If your property is consistently over budget in a category, what can you do to decrease that cost? Could you renegotiate a contract with the service provider? Does the property need energy-efficient upgrades? Is it time to raise the rent?
No matter what action plan you decide on, use these budget variances to create a more accurate budget for next year.
• Review key performance indicators.
Your key performance indicators can also show you which areas need attention. If you’re not happy with your debt service coverage ratio, focus on debt repayment in the new year. If your vacancy rate is an issue, updating your tenant screening and communications may be a better priority for you.
• Plan improvements.
Don’t let large expenditures catch you by surprise. A capital spending study helps you estimate how much an improvement will cost and when you’ll need to make the improvement. This will allow you to build up your savings account, research service providers, and be ready when it’s time to update the property.
• Set up or strengthen your safety net.
Your cash reserve helps you cover unexpected expenditures and fund planned spending. If you don’t have one, or your reserve is lower than you’d like, make saving a priority for the coming year.
• Update your portfolio.
Are you ready to grow your portfolio? Or maybe it’s time to sell a property that’s not performing well. Both buying and selling rental property take time and research. So if you need to update your portfolio, think about how that will affect your time and budget for next year.
Takeaways
Reviewing your rental property’s account books before the end of the year helps get you ready for tax season—plus it gives you a chance to adjust your tax strategy and maximize your deductions for this year. With up-to-date financial reports, you can also set goals for your real estate investments for next year. Use our annual review outline to finish out the year knowing your business is in order and be ready for the new year.
