Year-end close for landlords

Year-end close for a rental business is a four-week project that most landlords do as a four-day scramble in early April, which is the wrong time and the wrong duration. Done correctly, the work is mostly mechanical and most of it can be finished in January. Below is the order of operations, what your CPA actually needs from you, and the line items most small landlords get wrong.

The four-week timeline

Week 1 (early January): Reconcile

• Reconcile every bank account against December statements. The most common problem is uncleared checks more than 90 days old, which usually means a vendor never deposited it. Investigate before voiding.
• Reconcile credit card accounts the same way.
• Reconcile security-deposit trust accounts against the deposit ledger. The bank balance should equal the sum of held deposits, exactly. If it doesn't, find the difference before doing anything else; this is a serious compliance issue.

Week 2 (mid-January): Categorize

• Review every uncategorized transaction. Assign to a property and to an expense category.
• Re-examine large or unusual entries. Anything more than $2,000 in a single line item should be cross-checked against an invoice or receipt.
• Apply the repairs-versus-improvements judgment to anything in the maintenance accounts (next section).

Week 3 (late January): Issue 1099s and owner statements

• Run a vendor spend report. Issue 1099-NEC to every service vendor over $600 (with the corp/LLC exceptions).
• Send year-end owner statements with full-year P&L by property and a separate capital-improvements list.
• Send tenant year-end summaries if your local market expects them (some areas tenants need this for state tax purposes).

Week 4 (February): CPA handoff

• Compile the package described below.
• Send to your CPA by February 15. This gives them six weeks before the April deadline, which is what you want.

What your CPA needs

The standard package, in order:

1. Property summary: for each property, the address, date placed in service, original cost basis, land value (separated out, since land doesn't depreciate), and any major improvements made in prior years that are being depreciated.
2. Profit and loss by property for the year, in the categories matching Schedule E lines.
3. Capital improvements list: any improvement made during the year, with date placed in service, vendor, cost, and short description. Separate from operating expenses.
4. Mortgage statements: year-end statement (Form 1098) for each mortgage, showing interest paid, principal paid, and current balance.
5. Property tax bills paid: with dates and amounts.
6. Insurance premiums: by property, with effective dates.
7. HOA dues paid: by property.
8. 1099s issued (copies for the CPA file).
9. Vehicle log if you claim auto expenses, with business miles and total miles.
10. Home office details if you claim a home office: square footage, total home square footage, total home expenses by category.

Depreciation, in plain language

The IRS treats a residential rental building as having a useful life of 27.5 years. Each year you can deduct 1/27.5 of the building's cost basis (not including land) as depreciation. This is true whether you actually wear out the building or not.

Example: you bought a duplex for $400,000. The land was assessed at $80,000 (so the building portion is $320,000). Annual depreciation: $320,000 / 27.5 = $11,636.36. This deduction reduces your taxable rental income each year for 27.5 years.

The complication: depreciation is "recaptured" when you sell. The IRS treats the depreciation you took as taxable gain on sale, at a maximum 25% rate. This isn't a reason to skip depreciation — the tax-deferral value over decades almost always exceeds the recapture cost — but it's the reason your CPA will track the accumulated depreciation across the life of the property.

Repairs versus improvements, with examples

The single most common audit issue. Repairs are deductible this year. Improvements must be capitalized and depreciated.

The "maybe" cases get decided based on whether the activity restored the property to prior condition (repair) or improved it materially (capitalize). When unclear, capitalize and discuss with your CPA. The IRS rarely challenges capitalization but routinely challenges deductions for what they consider improvements.

The de minimis safe harbor

Small landlords can elect to expense improvements under $2,500 per item per invoice instead of capitalizing them, under the IRS's de minimis safe harbor. To use it, you need a written policy in place by January 1 of the year you're claiming it (a one-paragraph note signed and dated counts), and you have to apply the policy consistently. Talk to your CPA before electing — it interacts with other elections.

Line items most landlords get wrong

• Mortgage principal as an expense. It isn't. Only the interest is deductible. The principal portion goes against the loan balance, not income.
• Their own labor as an expense. Sweat equity isn't deductible. You can only deduct cash you paid out.
• Capital improvements deducted as repairs. The audit risk item. Be honest about which is which.
• Tenant security deposits as income. Not income until you forfeit them or apply them to damage. They're a liability on the balance sheet, not income on the P&L.
• Personal use mixed in. If you stayed in the rental for two weeks, you have to allocate a portion of expenses to personal use. The IRS pays attention to this.

What to do all year so February is easier

The deepest source of February pain is poorly categorized transactions throughout the year. Three habits that pay back massively:

1. Every transaction gets categorized within seven days. Not in batches at year-end.
2. Every receipt or invoice gets attached to the transaction in your books. Photos are fine.
3. Every capital improvement gets its own line item with a description and the in-service date.

If you do those three things, year-end close is a few hours of reconciliation and a CPA handoff. If you don't, it's three weekends of forensic bookkeeping in a month when your CPA is already overwhelmed. Move the work to January and your tax season becomes uneventful.