Income

• In general, you must report all rental income receive -- which encompasses any and all payments collected for the use or occupation of the property -- in the year you received it. Besides the regular rent payments you receive, rental income includes rent paid in advance (first and last months' rent), tenant payments for a lease cancellation and any expenses paid by a tenant for maintenance of the rental property. A security deposit is not included in rental income if you intend to return all of it when the tenant vacates, but you must include as income any portion of the security deposit you keep to prepare the property (repairs or cleaning) for the next tenant.
  
  

Expenses

• It is highly advisable to save all documentation and receipts for expenses incurred to maintain or prepare your rental property for occupancy. Rental property expenses are reported in the same year you pay for them, and typical expenses include repairs, cleaning and maintenance, property depreciation, insurance, mortgage points and interest payments, advertising, legal fees, utilities, travel expenses, taxes and tax preparation costs. If you have a management company that handles finding new tenants, does all repairs and maintenance on the property and who generally deals with all tenant- or property-related issues, your tax deduction limitations for your rental property include rental income only.
  
  

Improvements

• Property improvements fall within the category of deduction limitations for rental property. An improvement adds to the value of your property, increasing its useful life, and includes adding a bathroom or bedroom, new roofing, finishing a basement, new fencing, wiring or plumbing, new cabinets or driveway surfacing. Costs for improvements must be capitalized (treated as a capital improvement), and then the cost can be depreciated as if the addition or improvement were a separate property.
  
  

Depreciation

• The depreciation on a rental property indicates the loss of value to a property over time, due to normal wear and tear. Depreciation can be a valuable tax deduction, and in the case of property improvements, you can deduct a portion of the value lost every year for a specified number of years. For example, appliances and carpeting in a rental home are typically depreciated over a five-year period, and the value of the entire property can be depreciated over 27 1/2 years. Deductions for depreciation of the entire rental property can begin as soon as the home is ready for occupancy, even if there are no tenants yet, but you must stop depreciation deductions once you recover your cost for the property or stop renting the home, whichever occurs first.