Fortunately, most rental property ownership will initially generate taxable losses for you, which may save you some money on your taxes. These savings come from shielding, or deducting, losses against part of your regular taxable income. But keep in mind, taxable losses are different from positive or negative cash flows.

For our purposes, we’re just going to discuss what you need to do as a landlord to get your taxes heading in the right direction.

Income and expenses

In April you’ll add an IRS 1040 Form Schedule E (Supplemental Income and Loss From Real Estate) when you file your taxes.

On Schedule E, you’ll record all the rental income you received for the prior year. Then you will record all the cash expenses related to the property: mortgage interest, property taxes, HOA fees — which are now deductible because it is a rental property instead of a personal residence — maintenance and repairs, gardening costs and any other expenses, such as depreciation (described below) that are related to the operation of  your “business.”

The net rental income, less all those expenses, will provide an income or loss figure that will be calculated on Schedule E and flow to your IRS 1040 Form, Line 17. So if rental income is $20,000 and expenses are $23,000, you have a $3,000 loss for tax purposes.

Depreciation

One favorable expense deduction that you can take against rental income is called depreciation. It is usually a large amount and can help you greatly decrease the taxes you pay. To figure out this amount, first, you need to determine the tax basis and depreciable basis of your rental property. The tax basis will generally be what you originally paid for the property, plus any capital improvements you’ve made over the years. So if you paid $175,000 and put in a $10,000 addition, your taxable basis is $185,000.

You’ll then split that basis into land value and building value, which is your depreciable basis. Divide that building value by 27.5 years to get your depreciation deduction, which goes on your Schedule E just like any other expense. I would advise that you have your accountant help you with this calculation.

Adding it up

Now let’s look at how the Schedule E income or loss flows to your main 1040 form. You would take your net income or loss on the Schedule E form and transfer it to your 1040. If it’s a loss, you save money on taxes. If it’s positive income, you pay additional taxes.

Note: On losses, there are some “Passive Activity Loss” limitations on using losses to shield income. The net maximum loss you can use to shield income is $25,000, and the ability to use any losses phases out starting at $100,000 adjusted gross income. Real estate professionals, however, may be able to use unlimited losses. Talk to a tax professional on all these issues.

Do some Internet research, talk to your tax professional, look at the Schedule E form, save all those receipts and make sure you maximize your deductions, especially depreciation, so you get the largest possible tax savings the IRS code allows.