Keep Good Property Records

One of the major advantages of investing in real estate is the availability of numerous tax deductions. It goes without saying that every investor wants to maximize his or her allowable tax advantages. In order to do that, clear, accurate and comprehensive documented records must be maintained. Such records are vital in the preparation of your yearly tax return, and they'll also come in very handy if you're ever audited by the IRS.

In addition to helping satisfy government requirements, complete and detailed records also allow you to evaluate the performance of the property before deciding to improve it or put it on the market. Furthermore, good records are needed in order to refinance if you choose to take some of your profits out while still holding ownership, and to help convince someone else to buy the property when you're ready to sell. In fact, maintaining and reviewing your property's records will allow you (with the aid of a good tax advisor) to run figures using every available method of calculation. With such records in hand, you'll be much better able to anticipate and avoid potential problems and pitfalls, and you can better pursue the most favorable tax treatment afforded by the property.

As a real estate investor, what types of things should you keep records of? The most basic items are listed below. As you progress, feel free to add any other areas that may be important to your particular property or investment situation.

The purchase contract and closing statement. It's absolutely essential to document the price that you paid for the property because it establishes the basis upon which depreciation will be calculated and from which your capital gains will be figured for tax purposes.

All expenditures for capital improvements. A capital improvement is one that will extend the useful life of a property or add to its value. For example, adding a new roof or installing new windows is a capital improvement; repairing a broken window or painting a structure's interior is not. The latter fall under the heading of maintenance or repair items. If capital improvements are made to a property before putting it into service and collecting rents, their cost can be added to the property's purchase price and used to raise the basis. If, on the other hand, capital improvements are made after the property has been in service for a while, they can still be depreciated but they must be done so separately from the purchase price basis depreciation – by use of the Modified Accelerated Cost Recovery System (MACRS). Capital improvements can be depreciated according to MACRS; maintenance costs, however, can't. Your records of capital improvements and their depreciation are therefore needed to establish your adjusted basis (the figure used for computing capital gains on investment property).

All rental income. Detailed records should be kept for all security deposits received along with their disposition, all rents received, and any vacancy periods suffered by the property.

All operating expenses. Operating expenses include management fees, maintenance and repair expenses, utilities, advertising costs, property taxes, mortgage payment interest, insurance, real estate commissions, travel expenses to and from the property, legal and accounting fees, etc. These expenditures are deductible from rental income and can therefore reduce your tax liability.