What Investors Should Know to Maximize Deductions & Avoid Overstating Income

by | BiggerPockets.com

We all know the importance of reporting the correct income and expenses for our businesses on our tax returns. You of course do not want to exaggerate deductions, as that would be unethical, but you also do not want to understate them either and miss out on deductions that you are entitled to. To save money during tax time, you need to make sure that you haven’t overstated your income or understated your deductions. While it may seem silly to do either, it is a common mistake that many investors make, and many don’t even realize it. Here are some of the important things to note as we head into tax season.

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Should you Report Security Deposits as Income?

Don’t report more income than you need to. Time and time again, I have seen investors include security deposits as income on their tax returns. Generally, security deposits are not considered rental income when you receive them, as you are holding onto them with the assumption that they will be refunded to the tenant upon move out. Do not include security deposits as rents received unless you note up front that it is non-refundable or if you withhold part of the deposit upon move out. Oftentimes things like pet or cleaning deposits are non-refundable, and those may need to be included as income.

Related: How to Prove Tax Deductions as an Investor: A Guide to Tracking Receipts

When refunding security deposits to tenants, make sure that you do not list these payments as expenses since you are just giving them back money that you were holding onto. If you withhold any amount for cleaning or damage, then pick it up as income, and at the same time write off any expenses paid to a cleaning or repair company. If you have a management company, make sure to double check the amount listed on your 1099s this year. If security deposits are included in the amount, have the management issue a corrected 1099.

Since the amount on the 1099 is reported to the IRS as your rental income for the year, you want to protect yourself by not paying taxes on security deposits. If you report less income than is on that form, then you may receive a letter from the IRS demanding more money, so make sure that both numbers match before you report the income on your tax returns.

Are You Capturing Indirect Expenses?

Most everyone picks up direct expenses when it comes to deductions. Property taxes, repairs, mortgage interest, and utilities are generally all accounted for on profit and loss reports. However, indirect expenses are often missed or sometimes intentionally skipped. These include things like office expenses, business meals and entertainment, cell phone bills, auto expenses, and home office deductions.

Some investors choose to exclude these deductions from their returns due to audit risks; however, these may all be legitimate business expenses. Do make sure that you have proof to take each deduction, but items such as home office deductions and meals and entertainment are generally valid deductions as long as they are taken within reason.

Investors are often concerned when it comes to indirect expenses that are split between business and personal use. Car expenses, home office, and cell phones are generally the main concerns in this area.

For auto deductions, make sure that you can prove business-related mileage by keeping a log or calendar of travels. For a home office, make sure that you have a designated workspace in your home and that you conduct the majority of your business from that space. To figure out business use for a cell phone, take a look at your bills from the past three months and figure out what percentage of calls were business-related. You may apply this percentage to your cell phone bills for the entire year and take a business deduction for that amount.

Remember to save the bills, receipts, logbooks, and any other documents that can help you prove these indirect expenses in the event of an audit. Don’t skip out on legitimate business expenses just because they may seem large or just because you worry that it will make you more likely to be selected for audit.

Home office deductions and auto expenses are common deductions that many investors take each year. As long as you have substantial proof for your expenses, you generally can take each deduction.

Are You Taking a Depreciation Deduction?

Another indirect expense is depreciation. This deduction is even better because you’re not paying any money out of pocket. Just make sure that you are actually taking the deduction on your tax returns. Recently, I got a call from a new client who realized a few years too late that his prior CPA had never included a depreciation deduction on his returns. Since 2006, the depreciation line on his tax return had been completely blank for all five of his properties. He missed out on tens of thousands of real estate deductions by not taking this freebie deduction.

Related: How an Investor Missed a $100K+ Tax Deduction (& How You Can Avoid This Costly Error!)

Luckily it was not all bad news for him, as he is currently undergoing a Cost Segregation Study in order to catch up all of the missed depreciation over the past several years. Make sure that you look at your prior year tax returns, and if you are missing a depreciation deduction, give your tax advisor a call right away to see what your options are for claiming those missed deductions.

This year, make sure that you are not overstating your income or understating your deductions. Everything adds up, so make sure that all deductions and income are correctly accounted for on your tax returns. Don’t leave money on the table! If you are not sure whether you should include an item as income or if an expense is deductible, ask your CPA before including or excluding it. Take a little more time this year with your taxes to ensure that you protect your hard earned money.

Investors: Questions or comments about your deductions this year?

Leave them below!

About Author

Amanda Han

Amanda is a CPA specializing in tax strategies for real estate, self-directed investing, and individual tax planning with over 18 years’ experience. She is also a real estate investor of over 10 years with a focus on long-term hold residential and multi-family assets across multiple states. Formerly a tax advisor at the prestigious accounting firm Deloitte in the Lead Tax Group, focusing on tax strategies for the real estate industry and high net worth individuals, and at an international Fortune 500 Company in the high-tech industry in the Corporate Tax department, Amanda’s goal is to help investors with strategies designed to supercharge their wealth building. Amanda’s highly rated book Tax Strategies for the Savvy Real Estate Investor is amongst Amazon’s best seller list. A frequent contributor, speaker, and educator to some of the nation’s top investment and self-directed IRA companies, Amanda has been featured in prominent publications including Money Magazine, Realtor.com, and AllBusiness.com. Amanda was a speaker at Talks at Google and is a 40 under 40 honoree by CPA Practice Advisor, showcased amongst the best and brightest talent in the accounting profession. Her firm Keystone CPA, Inc. was awarded a two-time winner of the Top CPA of Orange County Award by OC Metro Magazine. She is certified by the CA State Board of Accountancy and is a member of the prestigious American Institute of Certified Public Accountants (AICPA) with clients across the nation.


  1. Brock Adams

    Enjoyed the article you wrote. Great points on all areas. Question: In the past I have been limited to losses I can deduct on my income because of AGI threshold and therefore I am capped at 25,000 of loss against income with the left over carried forward. My attorney said if I could show that I meet some provisions as property manager and putting in the legitimate hours to manage properties I would be able to deduct more even though it is not my full time job and I am not a real estate professional . Maybe something I will discuss with my CPA this year..

  2. Russell Pitts

    Hi Amanda, what would you consider to be “substantial proof” in the case of the home office deduction? How do I “prove” this to the IRS if questioned? Other than showing them physical proof of my home office I’m not sure. I’m not talking about receipts of an office chair or file folders, etc.

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