Becoming a Landlord: Operating as a Landlord
As a landlord, you operate a rental property business. As with any business, you need to keep good records; file taxes and report income and expenses to the IRS; comply with local, state and federal laws; maintain various insurance policies and obtain legal services when needed.
Accounting and Recordkeeping
An important part of your business will be accounting and recordkeeping. You must keep accurate records of all income and expenses, and you must be able to provide documentary evidence – such as receipts, canceled checks and bills – that supports your expenses. You’ll use these records to monitor your rental property activities, prepare financial statements and provide evidence in case you are ever the subject of an IRS audit. (For more, see How Do IRS Audits Work?)
You can maintain your accounting records by using inexpensive journals and ledger sheets to track income and expenses, or you can use computer programs such as Microsoft Excel and Intuit's Quicken. There are also commercially available software packages – such as AppFolio and Buildium – developed specifically for property management. Regardless of which method you choose, it’s to your benefit to maintain up-to-date records from day one. It’s much easier to record a few income and expense lines each day than to play catch-up when tax time approaches.
Because tax laws are fairly complicated regarding rental property and rental income, it’s helpful to hire a qualified tax accountant to prepare your tax return and provide guidance for the favorable handling of current and future income and expenses.
As a landlord, you can claim certain tax benefits when you file your yearly income tax return and when you sell the property. To take advantage of the special tax treatments that are available to landlords, you must be aware of the benefits and understand how they work, taking them into consideration when you plan your rental property activities and expenses. You should be able to deduct the interest payments on your rental property mortgage, as well as the following expenses:
- advertising (to find both tenants and people to help you maintain the property)
- depreciation (for the home and the cost of major improvements that add value to the property)
- expenses for rental items for tenants' use
- insurance premiums
- losses from casualties or thefts (excepts for amounts reimbursed by insurance)
- outdoor painting
- property taxes
- rental losses (a deduction up to $25,000 is available to non-real estate professionals who own at least a 10% interest in a rental property they actively manage and that operates at a loss during the tax year)
- repair and routine maintenance costs
- tax preparation
- travel and transportation
- wages and fees paid to people you hire to help maintain the property
To be eligible to take these tax deductions, you must be able to prove that you intend to rent out the property for the long term, rather than for a short period of time (such as while you are waiting to sell the home). Signed long-term leases and copies of advertisements you placed supporting your intention to find long-term tenants can help provide the evidence you need if you are audited by the IRS.
Local, State and Federal Compliance
It may well be worth the money to consult with a qualified attorney to determine how to comply with local, state and federal laws and permitting and licensing requirements. A qualified attorney will be an expert in landlord-tenant law (i.e., don't consult a criminal defense lawyer for advice regarding your rental property, even if he or she is your pro bono friend). You shouldn't skimp on this expense: Hire the right professional for the job.
Local housing codes determine requirements for the structure, facilities and essential services including water and heat. Local laws may also cover the same standards as state laws, such as raising rents, the handling of security deposits and the eviction of tenants. Your local building or housing authority may have copies of local laws and ordinances that affect landlord-tenant relationships. You can also check online or with your local public library, city manager or mayor's office.
State laws generally regulate landlord-tenant matters such as evictions, housing standards, landlord's right of entry, repairs and maintenance, and security deposits. You can contact your state's consumer protection agency or attorney general's office to obtain copies of pamphlets or brochures that describe state laws regarding landlord-tenant relationships. Because laws change periodically, it’s important to request updated information on rental laws and statutes.
Federal laws that pertain to landlord-tenant relationships cover discrimination and landlord responsibilities regarding environmental health hazards, including asbestos and lead paint. Landlords must follow the Civil Rights Act, which specifically prohibits race-based discrimination. They must also comply with the Fair Housing Act of 1968 and the Fair Housing Amendments Act of 1988, which prohibit discrimination based on the following:
- race or color
- national origin
- familial status or age (including families with children and pregnant women)
In addition, the acts prohibit landlords from doing any of the following:
- advertising or making statements that show a preference or limitation based on a protected class (such as race or gender)
- falsely stating that a rental unit is unavailable
- setting different or more restrictive standards for certain tenants (such as requiring a larger security deposit)
- refusing to rent to members of certain groups
- setting different terms or conditions for certain tenants, before or at any time during the tenancy
- ending a tenancy for any reason that can be attributed to discrimination
You can read about federal laws in the U.S. Code, available in many public libraries, or in the Code of Federal Regulations. While no landlord is exempt from the Civil Rights Act, federal fair housing laws don’t apply in certain situations:
- owner-occupied buildings with four or fewer rental units
- single-family housing that is rented out without advertising or the assistance of a real estate agent/broker (provided the landlord owns three or fewer such homes)
- housing operated by certain religious organizations and private clubs who rent solely to their own members
- housing that specifically serves senior citizens (including "62 and older" and "55 and older" communities)
Even if you’re exempt from federal fair housing laws (for example, you have an owner-occupied building with three rental units), you may still be required to comply with similar state laws, and all landlords must follow the fair housing laws that prohibit discrimination in advertising. It’s your responsibility to know, understand and comply with all local, state and federal laws. Ignorance of the law is no excuse.
Before you rent your property, it’s a good idea to consult with an attorney who specializes in landlord-tenant law to confirm that you are in compliance with all local, state and federal laws. Your attorney can also review the lease that you plan to use to make sure it protects you and contains the proper language – it’s possible for a novice landlord to be outfoxed by a professional tenant. Remember, a lease is a legal document that specifies the terms of the landlord-tenant relationship. Your attorney can make sure the document provides a legal basis for enforcing rental policies.
In the event a tenant files a lawsuit against you, your attorney can provide guidance to help protect you and your assets. And if you need to evict a tenant, it’s helpful to consult with an attorney who can help you successfully navigate through the process and avoid mistakes.
A standard homeowner's insurance policy covers owner-occupied residences and probably won't cover losses sustained while a tenant occupies the property. You’ll need a landlord-specific insurance policy, and you should expect to pay a bit more for it than a homeowner's policy because your tenants are viewed as higher risk than you are. That's because the typical homeowner takes better care of his or her home than a tenant will. In addition, a homeowner is more likely to notice and respond to maintenance needs – such as a leaky faucet or roof – before they turn into bigger problems.
You should buy adequate insurance before renting out your property. At a minimum, it’s recommended that you have landlord liability insurance to protect you in case someone is hurt while on your property, and basic landlord property insurance to cover losses arising from fires, storms, theft and vandalism. Lenders typically require you to have basic property insurance on mortgaged property. Since your landlord policy will only cover losses related to your property and belongings, you should advise your tenants to purchase their own renter’s insurance to protect their personal property. (For related reading, see Renter’s Insurance: A Comprehensive Guide.)
In addition to liability and basic property insurance, there may be other policies – such as flood insurance – that are required if your rental property is located in certain areas. Even if these are optional, they may be worth considering. In most cases, a policy is very affordable compared to the potential financial losses you could sustain without the coverage. The various insurance companies may have different names for the policies, so it is important to find out exactly what you are purchasing – know what the policy covers and what is excluded.
If your rental property is located in an area deemed a "special flood hazard area" by the Federal Emergency Management Agency (FEMA), your lender will require you to have flood insurance on the property. A flood insurance policy is separate from your basic property insurance (which doesn’t cover losses resulting from floods). A "flood" is defined as an excess of water on land that is usually dry. Flood insurance protects you against losses from the overflow of inland or tidal waters, runoff of surface water, mudflow (i.e., landslides or mudslides) or erosion caused by water. Many losses due to floods occur in low-risk areas where you think you wouldn’t need the coverage.
Tenant relocation insurance covers your costs to move tenants to a different location if your property becomes uninhabitable due to damage caused by a fire or other disaster. Rent loss insurance protects you against the loss of rental income in the event that a fire or other disaster makes your rental property uninhabitable. Bonding protects you against losses if you or someone you hire is the victim of a robbery after collecting rents.