If you’re just getting started as a medium-term rental host, the accounting and tax requirements can seem arbitrary and mysterious. It’s easy to get lost in piles of paperwork and conflicting advice. While there’s no substitute for a competent CPA, there are a few key things you can do now to keep things simple and organized.
Please note: This article does not constitute tax or legal advice. We strongly encourage you to consult a qualified CPA when making tax and accounting decisions!
Step 1. Decide: Schedule E or Schedule C?
If you rent out your home for more than 14 days in a calendar year, the IRS considers this activity to be more than incidental. Once you cross the two-week threshold, you’re engaging in a business activity and you’ll need to report this activity separately on your tax returns. Medium-term rentals are, by definition, always longer than 14 days, so if you’re renting out your residence (or a vacation home or investment property) on Kopa, you’re in this bucket.
Most short-term rental hosts and nearly all long-term rental property owners file Schedule E with the IRS each year. The same will likely be true for you unless you’re participating in a multi-member LLC or other business entity. Schedule E is for “passive” activity, in which you are providing only minimal services to your renters. These services might include things like utilities, repairs, and payment of HOA dues. The big advantage of filing Schedule E is that the net income you report is not subject to self-employment tax.
Schedule C is a less frequently used option for reporting rental activity since it’s generally reserved for “active” operating businesses. This only applies to rental properties when the host is providing substantial in-stay services like meals, guided tours, transportation, and regular maid services. In these circumstances, hosts are presumed to be running an “active” business and are required to pay self-employment tax on the net profits.
Please note: As you might expect, there are many other nuanced considerations involved in deciding how to track and report your rental activities. You should absolutely consult a qualified CPA to solicit advice on your specific tax situation.
Step 2. Work backward to find your accounting baseline.
Once you’ve sorted out which IRS schedule you’ll use, work backward from there to arrive at the minimum amount of record-keeping you’ll need to do during the year.
You can of course track your income and spending in more detail if you like. This can sometimes make it easier to discover opportunities for cost savings and operational efficiencies, but the IRS doesn’t much care how much you spent on trash collection versus electricity. It all gets rolled up into a single “Utilities” category for tax reporting.
Assuming you’ll report on Schedule E, then the specific categories of information you need to track include:
- Number of days rented vs. days for personal use
- Rents received
- Royalties received
- Auto and travel
- Cleaning and maintenance
- Legal & other professional fees
- Management fees
- Mortgage interest paid to banks, etc.
- Other interest
- Depreciation expense or depletion
Now that you know what to track, let’s talk about how to do it efficiently.
Step 3. Choose the best accounting option for your situation.
It’s often best to approach a major decision by asking yourself some questions first. It’s a good way to make sure you’re choosing the right solution for your situation, instead of just following the herd. Ask yourself:
- Do you like learning to use new online tools?
- Do you need to keep track of multiple rental properties?
- Do you invest with partners and have complicated ownership structures?
- How dearly do you value your own time?
Generic spreadsheets: Google Sheets, Excel, Smartsheet
This is the ultimate DIY approach. If you’re comfortable moving data around yourself and are only keeping track of one or two properties, this approach can sometimes work. You’ll want to establish a routine of updating your spreadsheets on a regular basis, whether it’s weekly, monthly, or quarterly. Google Sheets is a good choice if you need to share access with a spouse or co-owner, but it definitely lacks some of the features and power of the desktop version of Excel. Excel is great if you want to run different analyses on your data and prefer to keep your information stored locally, instead of in the cloud. Smartsheet is a sort of Google Sheets on steroids that includes advanced features around project planning, checklists, reminders and notifications, and advanced team collaboration.
Purpose-built real estate software for landlords
With millions of rental property owners in the US alone, a few niche accounting software for landlords is now increasingly available via cloud-based platforms. Stessa is one of the more popular purpose-built options and can connect directly to your bank accounts to import your income and expense data automatically. Most transactions are categorized with machine learning. You can then run various reports for your CPA and track key real estate metrics without having to do the math yourself. Stessa also offers mobile versions of the platform for quick receipt scanning and other on-the-go functions. This is a great option if you’re tracking more than one rental property or want to run key financial reports throughout the year, instead of just once at tax time.
General-purpose accounting platforms like Quickbooks, Freshbooks, Wave
Off-the-shelf accounting software has been around for decades and Quickbooks is a popular choice among business owners and CPAs alike. It’s very powerful, which can sometimes work against you when you’re trying to keep it simple.If your rental properties are part of a larger business with other revenue lines and/or you have a complicated ownership structure with partners, Quickbooks can get you where you need to go. Just keep in mind that significant setup time is required in order to properly customize “classes” and categories for proper real estate tracking.Other cloud-based accounting programs like Freshbooks and Wave require similar levels of up-front customization to make them work for tracking rental properties. These platforms are designed for all sorts of small businesses, so you’ll likely end up paying for a lot of features that you won’t use. Still, these general accounting programs can be a good fit for landlords that want to learn the many nuances of rental property accounting for themselves.
Full-service bookkeeper to forward all your receipts, bank records, etc.
This is the fully outsourced option in which you cash checks, spend money as needed, and simply forward all receipts and bank statements to your bookkeeper. This approach will cost you, but for those who value their time at a very high hourly rate, it might make a lot of sense.The main challenges with this approach are that it can take time to find the right person and you’ll probably miss out on some opportunities to increase revenue and reduce costs. Your bookkeeper simply doesn’t have the same incentive as you do to analyze the numbers and look for opportunities. Sometimes, key insights only emerge when you combine your detailed knowledge of the property with a full view of the numbers.
Regardless of which accounting system you select, check in with yourself after the first month and make sure it’s working for you. It gets exponentially harder to pull the ripcord on an existing accounting system with each passing day.
Step 4. Set up a dedicated bank account for each property.
Finally, consider setting up a dedicated bank account to handle rental income and expenses related to your hosting activity. This can make things much easier to track since there will likely be far less activity in this account than your personal checking account.
Many online accounting platforms, Stessa in particular, now allow you to connect your bank and mortgage accounts online. If you have multiple properties, you can often map each separate bank account’s transactions directly to each property for complete automation. This saves you hours of hassle and works best when your linked bank account isn’t peppered with irrelevant personal transactions.
Create your accounting system today.
In our experience, the earlier you get an accounting system in place, the sooner you can stop sweating the details and focus on the big picture instead. You'll start to be able to answer important questions: “Am I making any money? Will I cover my mortgage this month? Should I buy another rental property?” The answers to key questions like these only emerge when you have full confidence in your numbers.