Does owning rental property in California have any special tax implications? There are certain scenarios where California’s rental income taxation can be different from other states.
Taxation of Rental Income
Let’s start with some basics of rental income taxation. This explanation applies to most states since it is based on IRS rules (i.e., federal rather than state).
The following is a rental property income statement template.
Income:
Rent
Allowable deductions:
Maintenance
Mortgage interest
Property management
Insurance
HOA dues
Property taxes
Utilities
Professional services
Depreciation
= Net profit (or loss)
Net profit is the amount taxed. Owners of rental properties can deduct a lot of expenses and deductions.
Some other considerations can affect income, such as:
- Advanced rent payments
- Keeping security deposits after a tenant moves out
- Expenses paid by a tenant if they are not obligated to pay them
- Barter arrangement — services from a tenant in exchange for rent payments
Depreciation is a non-cash expense that doesn’t affect cash flow. When income taxes are filed, they appear on the tax return. For many rental property owners, it is a significant deduction. It can even create a loss for the business, even when the business may have added money to its bank account.
When filing taxes, rental income is reported on Form 1040 Schedule E.
California Rental Income
Does California tax rental income differently? For a regular rental property, California taxes business owners the same. Income is still taxed at the owner’s ordinary income tax rate.
However, short-term rental property owners must meet specific restrictions to use rental property deductions.
California Short-Term Rental Income Taxation
In California, a short-term rental (STR) is defined by “California Senate Bill No. 60, Chapter, 307” as a residential dwelling, or any portion of a residential dwelling, that is rented to a person or persons for 30 consecutive days or less.
Why is this significant? STRs must collect Transient Occupancy Tax (TOT) under certain conditions. This tax is charged to the guest, but the property owner must collect it and pay it to the local (county) authorities. The tax varies by county.
STR taxation/rules vary by city. Here’s a link to San Francisco’s STR document. You can find similar documents for other large California cities.
Those renting their property for 14 days or less may be able to claim rental income tax-free. Keep in mind that you won’t be able to utilize rental property deductions under this scenario.
California Property Taxes
As mentioned above, property taxes are one of the deductions allowed by rental property owners. Property taxes are structured under Prop 13 in California. The following summarizes Prop 13:
- 1% of the value of property yearly. This is applied against the original purchase price.
- Up to a 2% increase per year. You’ll notice this is not inflation-adjusted, so your taxes will increase less than inflation, assuming inflation is over 2%.
Taxation is a complex topic because it is unique to each individual. Given the various rules and tax scenarios for California rental property owners, it’s advisable to work with a tax professional. This is to help you figure out which ones apply to your situation.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Examples shown are hypothetical and for illustrative purposes only.
