Basic Income Tax Rental Income and Expenses 21-1 Rental Income and Expenses Session 21 A A I I I I A OMB No. 1545-0074 Department of the Treasury Attachment Internal Revenue Service (99) Sequence No. MXA RD 10/6/11 Name(s) shown on return Your social security number Did you make any payments in 2011 that would require you to file Form(s) 1099? (see instructions) Yes No If "Yes," did you or will you file all required Forms 1099? Yes No If you are in the business of renting personal property, use (see instructions). If you are an individual, report farm rental income or loss from on page 2, line 40. Physical address of each property-street, city, state, zip Type-from list For each rental real estate property below listed, report the number of days rented at fair rental value and days with personal use. See Instr. 1 Single Family Residence 3 Vacation/Short-Term Rental 5 Land 7 Self-Rental 2 Multi-Family Residence 4 Commercial 6 Royalties 8 Other (describe) Subtract line 20 from line 4. If result is a (loss), see instructions to find out if you must file Deductible rental real estate loss after limitation, if any, on ( )( )( ) Add positive amounts shown on line 21. ( ) Combine lines 24 and 25. Enter the result here. Merchant card and third party payments (see instructions) . . . . . . Payments not reported to you on line 3a . . . . . . . . . . . . . . . Total not including amounts on line 3a that are not income (see instr) Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Auto and travel (see instructions) . . . . . . . . . . . . . . . . . . . Cleaning and maintenance . . . . . . . . . . . . . . . . . . . . . . . Commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal and other professional fees . . . . . . . . . . . . . . . . . . . Management fees . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage interest paid to banks, etc. (see instructions) . . . . . . . . Other interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation expense or depletion . . . . . . . . . . . . . . . . . . . Other (list) Total expenses. Add lines 5 through 19 . . . . . . . . . . . . . . . . (see instructions) . . . . . . . . . . . . . . . . . . . . Total of all amounts reported on line 3a for all rental properties . . . . . . . . . . . . . . . . . Total of all amounts reported on line 3a for all royalty properties . . . . . . . . . . . . . . . . Total of all amounts reported on line 4 for all rental properties . . . . . . . . . . . . . . . . . Total of all amounts reported on line 4 for all royalty properties . . . . . . . . . . . . . . . . . Total of all amounts reported on line 12 for all properties . . . . . . . . . . . . . . . . . . . . Total of all amounts reported on line 18 for all properties . . . . . . . . . . . . . . . . . . . . Total of all amounts reported on line 20 for all properties . . . . . . . . . . . . . . . . . . . . include any losses . . . . . . . . . . . . . . . . . . . . . . Add royalty losses from line 21 and rental real estate losses from line 22. Enter total losses here . . . . . . . If Parts II, III, IV, and line 40 on page 2 do not apply to you, also enter this amount on Form 1040, line 17, or Form 1040NR, line 18. Otherwise, include this amount in the total on line 41 on page 2 . . . . . . . . . . . . . . . (From rental real estate, royalties, partnerships, S corporations, estates, trusts, REMICs, etc.) Attach to Form 1040, 1040NR, or Form 1041. See separate instructions. Note. Schedule C Form 4835 Fair Rental Days Use Days Type of Property: 3a 3b 3b 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Form 8582 22 23b 23b 23c 23c 23d 23d 23e 23e 23f 23f 23g 23g Do not For Paperwork Reduction Act Notice, see the instructions. Schedule E (Form 1040) 2011 A B 2 1 QJV Personal A A B B C C Income: Properties A B C 3a 4 Expenses: 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Form 6198 . . . . . . . . . . . 22 23a 23a 24 Income. 24 25 Losses. 25 26 Total rental real estate and royalty income or (loss). 26 (Form 1040) 13 SCHEDULE E Part I Income or Loss From Rental Real Estate and Royalties Supplemental Income and Loss 2011
Transcript
Basic Income Tax Rental Income and Expenses 21-1
Rental Income and Expenses S e s s i o n 2 1
A A I II I
A
OMB No. 1545-0074
Department of the Treasury AttachmentInternal Revenue Service (99) Sequence No.
MXA RD 10/6/11
Name(s) shown on return Your social security number
Did you make any payments in 2011 that would require you to file Form(s) 1099? (see instructions) Yes NoIf "Yes," did you or will you file all required Forms 1099? Yes No
If you are in the business of renting personal property, use(see instructions). If you are an individual, report farm rental income or loss from on page 2, line 40.
Physical address of each property-street, city, state, zip Type-from list For each rental real estate propertybelow listed, report the number of days
rented at fair rental value and dayswith personal use. See Instr.
1 Single Family Residence 3 Vacation/Short-Term Rental 5 Land 7 Self-Rental2 Multi-Family Residence 4 Commercial 6 Royalties 8 Other (describe)
Subtract line 20 from line 4. If result is a (loss), seeinstructions to find out if you must fileDeductible rental real estate loss after limitation, if any,on ( ) ( ) ( )
Add positive amounts shown on line 21.( )
Combine lines 24 and 25. Enter the result here.
Merchant card and third party payments (see instructions) ......Payments not reported to you on line 3a ...............Total not including amounts on line 3a that are not income (see instr)
Advertising ...............................Auto and travel (see instructions) ...................Cleaning and maintenance .......................Commissions ..............................Insurance ................................Legal and other professional fees ...................Management fees ...........................Mortgage interest paid to banks, etc. (see instructions) ........Other interest ..............................Repairs .................................Supplies ................................Taxes ..................................Utilities .................................Depreciation expense or depletion ...................Other (list)Total expenses. Add lines 5 through 19 ................
(see instructions) ....................Total of all amounts reported on line 3a for all rental properties .................Total of all amounts reported on line 3a for all royalty properties ................Total of all amounts reported on line 4 for all rental properties .................Total of all amounts reported on line 4 for all royalty properties .................Total of all amounts reported on line 12 for all properties ....................Total of all amounts reported on line 18 for all properties ....................Total of all amounts reported on line 20 for all properties ....................
include any losses ......................Add royalty losses from line 21 and rental real estate losses from line 22. Enter total losses here .......
If Parts II, III, IV, and line 40 on page 2 do not apply to you, also enter this amount on Form 1040, line 17,or Form 1040NR, line 18. Otherwise, include this amount in the total on line 41 on page 2 ...............
IntroductionGenerally, taxpayers must include all amounts received as rent in their gross income. In addition to amounts received as regular rental payments, there are other amounts that may be considered rent, such as a forfeited security deposit or certain expenses paid by a tenant.
Taxpayers can deduct their ordinary and necessary expenses for managing, conserving, or maintaining rental property. Expenses can be deducted from the date the property is made available for rent, even if it has not yet been rented.
Schedule E, Supplemental Income and Loss, Part I, is used to report rental income and related expenses, and to calculate the income or loss from rental real estate activities.
ObjectivesAfter completing this session, you will be able to
Identify rental income
Recognize deductible rental expenses
Determine deductible expenses when property is changed to rental use
Calculate depreciation on rental property
Identify and apply the limits on rental losses
Identify where to report rental income or loss
For additional information on topics covered in this session, refer to IRS Publication 17, Your Federal Income Tax,Part Two, Income.
21-6 Rental Income and Expenses Basic Income Tax
Lesson I: RentRent is any payment the taxpayer receives for the use or occupation of their property. In addition to regular rent payments, the following items are also considered rent when they are received:
Advance rent
Security deposit that a tenant forfeits or that is used as the last month’s rent
Lease cancellation payments
Expenses paid by the tenant
Property or services received in lieu of money
Lease payments received from a tenant who has the option to buy the property, before the date they actually purchase it
Advance Rent
Advance rent is any amount the taxpayer receives before the period that it covers. Include advance rent in the year it is received, regardless of the period it covers or the method of accounting used.
Example: Ari owns rental property, and Carlos has just signed a 10-year lease. In the fi rst year, Ari receives $5,000 for the fi rst year’s rent and $5,000 for the last year’s rent. Ari must include $10,000 as rent received in the fi rst year.
Security Deposit
A security deposit that the taxpayer plans to return to their tenant at the end of the lease is not included in income when it is received. However, if the taxpayer keeps part or all of the security deposit because their tenant does not live up to the terms of the lease, include the amount they keep in rent for that tax year.
If a payment is called a security deposit but is intended to be the fi nal rent payment, then it is advance rent and must be included in the taxpayer’s income when they receive it.
Advance Rent - Any rent received before the period that it covers.
Basic Income Tax Rental Income and Expenses 21-7
Example: Leita rented a two-bedroom apartment to Mark. Before Mark moved in, he gave Leita money to cover his fi rst month’s rent, plus a security deposit equal to one month’s rent. They both agreed to use the security deposit to cover the fi nal month’s rent, whenever that occurred. Leita must claim the entire payment received as rental income because the intent was for it to cover the fi rst and fi nal month’s rent.
Canceled Lease
If the tenant pays the taxpayer to cancel a lease, the amount paid is considered rent. Include the payment in rent in the year the taxpayer receives it, regardless of the taxpayer’s method of accounting.
Example: Andy and Sarah broke their lease agreement with Rental Properties, LLC by moving out of their apartment three months before the lease was complete. They paid a lease cancellation fee of $450. The entire $450 payment is considered rent.
Expenses
If the tenant pays for any of the taxpayer’s expenses, the payments are considered rent. The taxpayer can deduct the expenses if they are for an item that is a deductible rental expense.
Example: Anthony is a professional drywall installer who rents an apartment from Lisa. Anthony spent $250 on drywall and supplies to repair water damage in the apartment. Lisa agreed to reduce Anthony’s rent due for that month by the $250 Anthony spent on supplies. Lisa must claim the $250 as rent. However, she can also claim the $250 as a deductible expense when she fi les her tax return.
Property or Services
If the taxpayer receives property or services instead of money as rent,then the FMV of the property or services received is considered rent. If the services are provided at an agreed upon or specifi ed price, thisprice is recognized as the FMV unless there is evidence to the contrary.
Example: Brian is a tax preparation business owner. He rents a condo on the beach from Lydia. Brian and Lydia agree that Brian will prepare her personal income tax return for a reduction of his rent. They mutuallyagree that the value of the service is $300. Lydia must claim the $300 as rental income. Brian, too, will have to include the $300 as income when he fi les his tax return.
21-8 Rental Income and Expenses Basic Income Tax
Other Payments
If the taxpayer rents out property that they also use as their home, and they have a tenant for fewer than 15 days during the tax year, do not include the rent they receive in income and do not deduct rental expenses. The taxpayer can deduct on Schedule A, Itemized Deductions, the interest, taxes, and casualty and theft losses that are allowed for property that is nonrental property.
Example: Martina lives in the area where the Super Bowl was played. She decided not to stay in town during the two weeks prior to the event. She rented her property for the two weeks she was out of town. The rental income Martina received for this 14-day period will not be included in her income. However, if she itemizes her deductions, she will still be able to deduct her mortgage interest and real estate taxes associated with the property.
Cash-basis taxpayers report rent in the year they receive it. If the taxpayer owns a partial interest in rental property, include only their part of the rent from the property.
Knowledge Check One
1. Which of the following is not considered rent?
Advance rent
Lease cancelation payment
Refundable security deposit
Owner expenses paid by a tenant
2. Rico paid $1,200 to rent an apartment from Selena. Of this payment, $900 was for the fi rst month’s rent and $300 was a security deposit. Selena will return $300 to Rico when he moves out of the apartment. How much of this income should Selena report on her tax return as rent?
$300
$600
$900
$1,200
Basic Income Tax Rental Income and Expenses 21-9
3. Oscar paid a repairman $100 to fi x the dishwasher in the apartment he rents from Mary. He deducted the payment from his monthly rent of $1,000 and paid $900 for the month. How much rent did Mary receive for the month?
$100
$800
$900
$1,000
4. Helen rented a house from Frank. When she moved in, she agreed to paint the interior in exchange for one free month’s rent of $500. She spent $280 for paint and supplies. How much rent did Frank receive for the month?
$0
$280
$500
$780
5. Bob and Joan live next to a golf course. When a major tournament was held at the course, they rented their spare bedroom for the week to one of the participants for $1,000. This is the only rent they received during the year. How much must Bob and Joan include in their income?
$0
$500
$1,000
$1,500
21-10 Rental Income and Expenses Basic Income Tax
Lesson II: Rental ExpensesRental expenses are the ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining rental property. Cash-basis taxpayers deduct rental expenses in the year they pay them.
Any loss of rent for a period that a property is vacant is not deductible. Expenses incurred while rental property is vacant but available for use are deductible.
Example: Julie owns a condo that she rents out for $850 per month. When the condo is occupied for 12 months in a year, her rental income is $10,200. If the condo is only occupied for 10 months, she cannot take a deduction of $1,700. Instead, she reports $8,500 ($850 × 10 months) of rental income. During the time the condo is vacant, she is able to deduct her ordinary and necessary expenses associated with the property, such as real estate taxes and depreciation.
If the taxpayer sells property that they held for rental purposes, the ordinary and necessary expenses for managing, conserving, or maintaining the property until it is sold are deductible rental expenses.
Repairs
The cost of repairs to a rental property is a deductible expense, if the repair keeps the property in good operating condition. A repair does not materially add to the value of the property or substantially prolong its life.
Some examples of repairs include
Repainting the interior or exterior of the property
Fixing gutters or fl oors
Fixing leaks
Repairing broken windows
Repairs made as part of an extensive remodeling or restoration of the property are considered improvements.
If the taxpayer sometimes uses their rental property for personal purposes, special rules may apply, and their rental expense deductions may be limited. Refer to IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes).
Basic Income Tax Rental Income and Expenses 21-11
Improvements
An improvement made to a rental property is treated as a separate asset. The cost of most improvements can be recovered through depreciation.
An improvement is depreciable when it does one or more of the following:
Adds to the value of the property
Prolongs a property’s useful life
Adapts the property to new uses
Examples of improvements include
Installing new cabinets
Replacing the entire roof
Replacing windows and frames
Converting a garage to an apartment
Example: Melinda repaired the corner of her rental property’s roof where the shingles were damaged during a storm. This is considered a repair, not an improvement. If she replaced the entire roof, it would be an improvement to the property, not a repair.
Other Expenses
Other expenses that can be deducted include the following:
Advertising
Cleaning and maintenance services
Utilities
Fire and liability insurance
Legal and other professional fees, including tax preparation fees
Taxes
Interest on loans to acquire, repair, or maintain the property
Commissions for the collection of rent
Ordinary and necessary travel and transportation expenses
Rent the taxpayer pays for equipment they use for rental purposes
Land improvements may or may not be depreciable. Generally, depreciable land improvements are those that would lose their usefulness should the land be put to a different use, or those that would be damaged or destroyed if a building were replaced. Land itself is not depreciable.
21-12 Rental Income and Expenses Basic Income Tax
Yearly insurance premiums can be deducted in the year paid. If thetaxpayer pays an insurance premium for more than one year in advance, do not deduct the total premium in the year paid. Each year, deduct the part of the premium payment that applies to that year.
Taxpayers cannot deduct charges for local improvements that increase the value of their property, such as putting in streets, sidewalks, or water and sewer systems. These charges are capital expenditures that cannot be depreciated. Add these costs to the basis of the land.
Example: Trudy and Mike own a duplex they rent out to others. The town is rebuilding sidewalks in their neighborhood, including the sidewalkin front of their duplex. To pay for the sidewalk project, the town has levied a special assessment on all property owners in the area. The special assessment is not a deductible expense Trudy and Mike can claim on their tax return. Instead, they must add the cost of the assessment to the basis of the duplex.
The interest on loans secured by a rental property can be deductible, depending on how the taxpayer uses the proceeds of the loan. To be deductible as a rental expense, the taxpayer must use the proceeds to acquire, improve, repair, or maintain the rental property.
Taxpayers can deduct the following as rental expenses:
Local benefi t taxes - If used for maintaining, repairing, or paying interest charges for the benefi ts. These are not added to the property’s basis.
Ordinary and necessary expenses of traveling away from home - If the primary purpose of the trip is to collect rent or to manage, conserve, or maintain their rental property. The taxpayer must allocate their expenses properly between rental and nonrental activities during the trip.
Ordinary and necessary local transportation expenses - If incurred to collect rent or to manage, conserve, or maintain their rental property.
Part of their tax return preparation fees - Only the part paid to prepare forms and schedules relating to their rental property, or to resolve tax issues related to rental activities.
Basic Income Tax Rental Income and Expenses 21-13
Property Changed to Rental Use
If the taxpayer changes their home or other property to rental use, they must allocate their costs accordingly. Divide the yearly expenses, such as taxes and insurance, between rental use and personal use. Deduct as rental expenses only the amount for the part of the year the property was in service as a rental property.
Example: Markus moved from his home in May. He started renting it out to a tenant as soon as it was ready on June 1. For the current year, he can deduct as rental expenses seven-twelfths of his yearly expenses, for the seven months of the year his home was used for rental activity. Starting with June, Markus can deduct as rental expenses the amounts he paid for items generally billed monthly, such as utilities, and any specifi c expenses incurred, such as advertising.
Knowledge Check Two
1. Rental expenses are the ___________ expenses for managing, conserving, or maintaining rental property.
Actual and required
Expected and optional
Ordinary and necessary
Real and necessary
2. Which of the following is a rental expense that is fully deductible in the current year?
Expenses for the taxpayer’s main home
Improvements
Lost income due to vacancy
Repairs
Mortgage interest and real estate taxes for the part of the year the taxpayer used the property as a home can be deducted as an itemized deduction on Schedule A.
21-14 Rental Income and Expenses Basic Income Tax
3. Alyssa lived in her home until June 30. She began renting her house to a tenant on July 1. She had the following expenses for the year:
Real estate tax ............................. $2,000
New sprinkler system ................... $1,200
How much can Alyssa deduct for rental expenses?
$3,450
$4,050
$6,900
$8,100
Lesson III: DepreciationRental property is property held for the production of income. Taxpayers recover their costs in most income-producing real property, including property used for rental activities, through depreciation. They can deduct depreciation only on the part used for producing income. Rental real estate is one of the activities for which
Form 4562, Depreciation and Amortization, may be required to report depreciation.
The basis for depreciation is the lesser of either of the following:
The FMV of the property on the date the property is placedin service
The taxpayer’s adjusted basis on the date the property isplaced in service
For more information on depreciation, refer toSessions 19 and 20.
Basic Income Tax Rental Income and Expenses 21-15
The cost of land can never be depreciated because land does not wear out, become obsolete, or get used up. Land improvements that are permanent, such as clearing and grading, are not depreciable. Add nondepreciable land improvements to the basis of the land.
Depreciation reduces the taxpayer’s basis for calculating a gain or loss when property is sold or otherwise disposed. For this purpose, depreciation deductions include any depreciation the taxpayer was allowed to claim, even if they did not claim it.
The section 179 deduction cannot be claimed for assets purchased for use in a residential rental real estate property. The special depreciation allowance can be used if the property qualifi es under the general qualifi cations for the allowance.
Usually, property used in rental activities is depreciated under the regular Modifi ed Accelerated Cost Recovery System (MACRS). Property placed in service during the year for rental activities generally falls into one of the following property classes:
Nonresidential rental real property (39-year recovery period)
The IRS has MACRS tables to help calculate depreciation.
Table 2-1, MACRS Recovery Periods for Property Used in Rental Activities, from IRS Publication 527, shows some of the more common properties used in rental activities and their respective recovery periods.
Modifi ed Accelerated Cost Recovery System (MACRS) - The name given to tax rules relating to recovering, through depreciation deductions, the basis of most business and investment property placed in service after 1986.
Refer to the MACRS tables in Appendix L.
21-16 Rental Income and Expenses Basic Income Tax
Depreciable additions or improvements that the taxpayer makes to any property are treated as separate assets for depreciation purposes. If the improvement is physically attached to an asset and becomes an integral part of the property, the improvement is assigned the same property class and must have the same recovery period as the original asset.
Property Class - A category for property under the Modifi ed Accelerated Cost Recovery System that generally determines the depreciation method, recovery period, and convention.
Recovery Period - A predetermined number of years over which the cost or other basis of a property is recovered.
Table 2-1. MACRS Recovery Periods forProperty Used in Rental Activities Keep for Your Records
MACRS Recovery Period
General AlternativeDepreciation Depreciation
Type of Property System System
Computers and their peripheral equipment . . . . . . . . . . . . . 5 years 5 yearsOffice machinery, such as:
Residential rental property (buildings or structures)and structural components such as furnaces,waterpipes, venting, etc. . . . . . . . . . . . . . . . . . . . . . . 27.5 years 40 years
Additions and improvements, such as a new roof . . . . . . . . . The same recovery period asthat of the property to whichthe addition or improvement ismade, determined as if theproperty were placed inservice at the same time asthe addition or improvement.
Basic Income Tax Rental Income and Expenses 21-17
Example: Misha bought a rental house six years ago. The house is ‘Residential rental property’ with a recovery period of 27.5 years. Misha decides to replace the roof this year. The new roof is a separate depreciable asset. Because it is attached to the building, the recovery period for the roof is 27.5 years. This year, the house will be in its sixth year of depreciation, and the roof will be in its fi rst year of depreciation.
Depreciation for an addition or improvement to property begins on the later of the following dates:
The date the addition or improvement is placed in service
The date the property to which the addition or improvement was made is placed in service
Depreciation begins when property is placed in service. Property is considered placed in service in a rental activity when it is ready and available for rent. Depreciation continues even through periods when the property is not actually rented. Depreciation ends when the property is sold or disposed of, no longer used as a rental property, or when the property is fully depreciated, usually at the end of its recovery period.
The depreciable basis of a rental property is generally its cost or other basis, adjusted for certain items occurring before the property was placed in service in the rental activity.
Example: Deshawn bought a rental house in May. It needed a new roof and repairs. Deshawn spent three months doing the renovations. On September 4, it was suitable for tenants. Deshawn began advertising for a tenant September 4, and on October 1 his fi rst tenant moved in. Even though the house was not rented until October 1, it was placed in service and depreciation began on September 4, when the property was ready for its intended use. The cost of all repairs and renovations Deshawn made prior to September 4 increases the depreciable basis of the house.
If the taxpayer is changing property from personal use to rental use, the depreciable basis is the lesser of its adjusted basis, or its FMV on the date when changed to rental use.
21-18 Rental Income and Expenses Basic Income Tax
Knowledge Check Three
1. Serena bought a replacement dishwasher for her rental property on April 4. It was installed on May 1. Which of the following is true about the dishwasher?
The date depreciation begins is April 4.
It can be expensed under section 179.
It is depreciable property with a 5-year recovery period.
It is a repair and can be expensed in the current year.
2. John bought a rental property, and placed the following assets into service this year:
Rental house for $125,000 (excluding land value)on April 2
Refrigerator for $850 on June 1
Carpet for $2,200 on July 26
What is John’s depreciation deduction for his rental property, assuming the special depreciation allowance is not used?
$3,050
$3,830
$108,000
$128,050
Basic Income Tax Rental Income and Expenses 21-19
Lesson IV: Limits on Deductible LossesSubtract the taxpayer’s rental expenses from the rent they received to determine whether they have rental income or loss. Except for certain real estate professionals,rental real estate is considered a passive activity, and the amount of loss the taxpayer can deduct in the current year may be limited.
Passive activities include
Activities (trade or business) for which the taxpayer has no material participation
Any rental activity
In most cases, taxpayers cannot deduct losses from passive activities unless they have income from other passive activities. However, if the taxpayer actively participates in the rental activity, they may be able to deduct their losses up to $25,000 in the current year. This special loss allowance for rental real estate (special allowance) can be deducted from nonpassive income.
A taxpayer actively participated in a rental real estate activity if they meet both of the following requirements:
Owned at least 10% of the rental property
Made signifi cant and bona fi de management decisions
Management decisions include approving new tenants, deciding on rental terms, and approving expenditures.
If the taxpayer is fi ling as MFS and lived apart from their spouse for the entire tax year, their special loss allowance is limited to $12,500. If the taxpayer lived with their spouse at any time during the year and is fi ling a separate return, they cannot use the special loss allowance to reduce their nonpassive income or their tax on that nonpassive income.
Excess losses are carried forward to the next year. Accumulated unallowed losses increase basis upon disposition of the property.
Passive Activity - Generally, a trade or business activity in which a taxpayer did not materially participate and any rental activity (except a rental activity for those who qualify as real estate professionals).
Material Participation - The satisfaction of one of several tests used to determine that a trade or business is not a passive activity. Generally, material participation in an activity includes being involved in its operations on a regular, continuous, and substantial basis during the year.
The 10% ownership test can be met on a MFJ return by combining the taxpayer’s and their spouse’s shares.
Taxpayers with rental losses may be subject to the at-riskrules, which can limit the lossesthey can claim. For additional information, refer to IRS Publication 925, Passive Activity and At-Risk Rules.
21-20 Rental Income and Expenses Basic Income Tax
Example: Mark and Cathy are married and lived together all year. They had a loss from a real estate activity of $5,000. They had no passive income. If they fi le jointly, they can use the $5,000 loss to reduce their other income. However, if Mark and Cathy fi le separately, neither can take any of the loss in the current year.
The maximum amount of the special allowance is reduced if the taxpayer’s modifi ed AGI is more than $100,000 ($50,000 if the taxpayer’s fi ling status is MFS). The special allowance is reduced to zero when the taxpayer’s modifi ed AGI reaches $150,000 ($75,000 if the taxpayer’s fi ling status is MFS).
Knowledge Check Four
1. Joshua had total rental real estate losses of $3,500. Which of the following would not limit his deduction for the current year?
He holds a 5% interest in the property.
Joshua lived in the house several years ago.
He does not make any decisions about the renting ofthe property.
He and his wife live together and use MFS as theirfi ling status.
2. The maximum amount of the special allowance for deducting rental losses is reduced if a MFJ taxpayer’s modifi ed AGI is more than ___________.
$25,000
$100,000
$108,000
$430,000
Passive Income - Income from a trade or business activity in which a taxpayer did not materially participate and income from all real estate activities, regardless of their participation (except rental activities for those who qualify as real estate professionals).
Basic Income Tax Rental Income and Expenses 21-21
Lesson V: Reporting Income or LossIt is not enough for the taxpayer to know the rental income, expenses, and allowable deductions for their rental property. Use these amounts to determine their real estate income or loss. Calculate the taxpayer’s income or loss from their rental real estate activities on Schedule E, Supplemental Income and Loss, Part I, partially shown in Figure A.
Figure A - Partial View of Schedule E, Part I
The total amount of income or loss from Schedule E, Line 26, is entered on Form 1040, “Income” section, Line 17, as shown in Figure B .
Figure B - Form 1040, “Income” Section
Enter the following on Schedule E, Part I:
Rents received - Line 3
Expenses - Lines 5 through 17
Depreciation - Line 18
iwn ina,
, ab
Add positive amounts shown on line 21.( )
Combine lines 24 and 25. Enter the result here.
include any losses ......................Add royalty losses from line 21 and rental real estate losses from line 22. Enter total losses here .......
If Parts II, III, IV, and line 40 on page 2 do not apply to you, also enter this amount on Form 1040, line 17,or Form 1040NR, line 18. Otherwise, include this amount in the total on line 41 on page 2 ...............
Do not24 Income. 2425 Losses. 2526 Total rental real estate and royalty income or (loss).
26
NAOMI SANAI 400-00-1801X
RESIDENTIAL RENTAL412 FRIENDSHIP LANE 1
8,400 8,400
75 275
750
2,700
125 50 1,150
2,919
8,044
356
NONE
8,400 NONE 2,700 2,919 8,044
356 NONE
a
A IA
interest.
If you did notTaxable amountget a W-2, see
instructions. Taxable amount
Enclose, but donot attach, anypayment. Also, Taxable amountplease use
Other income. List type and amount
pWages, salaries, tips, etc. Attach Form(s) W-2 ..........................
interest. Attach Schedule B if required ..........................include on line 8a ..........
Ordinary dividends. Attach Schedule B if required ........................Qualified dividends .........................Taxable refunds, credits, or offsets of state and local income taxes ................Alimony received ..........................................Business income or (loss). Attach Schedule C or C-EZ ......................Capital gain or (loss). Attach Schedule D if required. If not required, check here ....Other gains or (losses). Attach Form 4797 .............................IRA distributions ..........Pensions and annuities ......Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E ....Farm income or (loss). Attach Schedule F .............................Unemployment compensation ...................................Social security benefits ......
Combine the amounts in the far right column for lines 7 - 21. This is your
78aa Taxable
8bTax-exempt Do notAttach Form(s) 9aaW-2 here. Also b 9battach Forms
10W-2G and1099-R if tax 11was withheld. 12
1314
15a 15b15 a b16a 16b16 a b
171819
20a 20b20 a b21Form 1040-V.22
78
b9
1011121314
171819
2122 total income ..
Income
NAOMI SANAI 400-00-1801
123 MAIN STREET
YOUR CITY, FL 34208
X
X 1
1
356
NONE 356
P i d i i
Farm income or (loss). Attach Schedule F .
16bTaxable amount1616 a Pensions and annuities 16a
1818Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E . 1717
b
Beginning in 2011, qualifi ed joint ventures reporting rental real estate income not subject to SE tax must report that income on Schedule E instead of Schedule C, Profi t or Loss From Business.
21-22 Rental Income and Expenses Basic Income Tax
Complete Form 4562 for the rental activity only if the taxpayer is claiming at least one of the following:
Depreciation or amortization on property placed in service during the current year
Depreciation on any property that is listed property (such as a car), regardless of when it was placed in service
Any car expenses (using actual expenses or the standard mileage rate) not reported on Schedule C, or Schedule C-EZ, Net Profi t From Business
Use a depreciation worksheet to document the depreciation taken each year, and save it for next year. This worksheet provides the taxpayer with the historical information necessary to calculate the basis when they dispose of the property.
Illustration One
Justin Cole is single. On June 1, 2010, he bought and placed a townhouse in service as residential rental property. Justin receives $1,100 rent per month (12 × $1,100 = $13,200). His rental expenses for the year are as follows:
Commission paid for collecting rent ..............................$572
General repairs .............................................................$175
Real estate taxes paid ..................................................$845
Justin’s basis for depreciation of the townhouse is $100,000. His depreciation is calculated using MACRS with a 27.5-year recovery period. On April 1, 2011, Justin purchased and placed in service a new refrigerator for the rental property for $725. MACRS with a 5-year recovery period is used for this calculation without a special depreciation allowance.
Because he has property placed in service in the current year, Justin’sdepreciation must be reported on Form 4562, Page 1. His depreciationworksheet, Form 4562, and net rental income or loss, as calculated on Schedule E, Part I, are shown.
e ty J HA
........B
........C
........D
........E
........F
. OrefrigG p
. Mon witH
urrent. H
aI.
a. H
a J
Basic Income Tax Rental Income and Expenses 21-23
A A I II I
A
OMB No. 1545-0074
Department of the Treasury AttachmentInternal Revenue Service (99) Sequence No.
MXA RD 10/6/11
Name(s) shown on return Your social security number
Did you make any payments in 2011 that would require you to file Form(s) 1099? (see instructions) Yes NoIf "Yes," did you or will you file all required Forms 1099? Yes No
If you are in the business of renting personal property, use(see instructions). If you are an individual, report farm rental income or loss from on page 2, line 40.
Physical address of each property-street, city, state, zip Type-from list For each rental real estate propertybelow listed, report the number of days
rented at fair rental value and dayswith personal use. See Instr.
1 Single Family Residence 3 Vacation/Short-Term Rental 5 Land 7 Self-Rental2 Multi-Family Residence 4 Commercial 6 Royalties 8 Other (describe)
Subtract line 20 from line 4. If result is a (loss), seeinstructions to find out if you must fileDeductible rental real estate loss after limitation, if any,on ( ) ( ) ( )
Add positive amounts shown on line 21.( )
Combine lines 24 and 25. Enter the result here.
Merchant card and third party payments (see instructions) ......Payments not reported to you on line 3a ...............Total not including amounts on line 3a that are not income (see instr)
Advertising ...............................Auto and travel (see instructions) ...................Cleaning and maintenance .......................Commissions ..............................Insurance ................................Legal and other professional fees ...................Management fees ...........................Mortgage interest paid to banks, etc. (see instructions) ........Other interest ..............................Repairs .................................Supplies ................................Taxes ..................................Utilities .................................Depreciation expense or depletion ...................Other (list)Total expenses. Add lines 5 through 19 ................
(see instructions) ....................Total of all amounts reported on line 3a for all rental properties .................Total of all amounts reported on line 3a for all royalty properties ................Total of all amounts reported on line 4 for all rental properties .................Total of all amounts reported on line 4 for all royalty properties .................Total of all amounts reported on line 12 for all properties ....................Total of all amounts reported on line 18 for all properties ....................Total of all amounts reported on line 20 for all properties ....................
include any losses ......................Add royalty losses from line 21 and rental real estate losses from line 22. Enter total losses here .......
If Parts II, III, IV, and line 40 on page 2 do not apply to you, also enter this amount on Form 1040, line 17,or Form 1040NR, line 18. Otherwise, include this amount in the total on line 41 on page 2 ...............
Attach to Form 1040, 1040NR, or Form 1041. See separate instructions.
Note.Schedule C Form 4835
Fair RentalDays Use Days
Type of Property:
3a3b 3b
4
567891011121314151617181920
21
Form 8582 22
23b 23b23c 23c23d 23d23e 23e23f 23f23g 23g
Do not
For Paperwork Reduction Act Notice, see the instructions. Schedule E (Form 1040) 2011
AB
21 QJVPersonal
AA
BB
CC
Income: PropertiesA B C
3a
4Expenses:
56789
101112131415161718192021
Form 6198 ...........22
23a 23a
24 Income. 2425 Losses. 2526 Total rental real estate and royalty income or (loss).
26
(Form 1040)
13
SCHEDULE E
Part I Income or Loss From Rental Real Estate and Royalties
Supplemental Income and Loss2011
JUSTIN COLE 400-00-1800X
RESIDENTIAL RENTAL5050 RIVER ST 1
113,200 113,200
572 1,210
5,083
175
845
3,781
11,666
1,534
NONE
13,200 NONE 5,083 3,781 11,666
1,534 NONE
1,534
A
B
C
D
E
F
(Form 1040) 20111,,,,,,534
1
J
21-24 Rental Income and Expenses Basic Income Tax
A A
A
A I
OMB No. 1545-0172
Form
Department of the Treasury AttachmentInternal Revenue Service (99) Sequence No.
Cost (business use only) Elected costDescription of property
Month and Basis for depreciationClassification of property Recovery Convention Method Depreciation(business/investment useyear placed in period deductiononly - see instructions)service
Form (2011)
F 11/18/11
MXA
Business or activity to which this form relatesName(s) shown on return Identifying number
If you have any listed property, complete Part V before you complete Part I.
Tentative deduction. Enter the
Do not use Part II or Part III below for listed property. Instead, use Part V.
include listed property.) (See instructions.)Special depreciation allowance for qualified property (other than listed property) placed in service
include listed property.) (See instructions.)
If you are electing to group any assets placed in service during the tax year into one or more general
25-year property 25 yrs. S/L27.5 yrs. MM S/L
property 27.5 yrs. MM S/L39 yrs. MM S/L
property MM S/L
S/L12 yrs. S/L40 yrs. MM S/L
(See instructions)
Add amounts from line 12, lines 14 through 17, lines 19 and 20 in column (g), and line 21. Enter here
Maximum amount (see instructions) .............................................Total cost of section 179 property placed in service (see instructions) ...........................Threshold cost of section 179 property before reduction in limitation (see instructions) ..................Reduction in limitation. Subtract line 3 from line 2. If zero or less, enter -0- ........................Dollar limitation for tax year. Subtract line 4 from line 1. If zero or less, enter -0-. If married filing separately, see instrs .
Listed property. Enter the amount from line 29 .........................Total elected cost of section 179 property. Add amounts in column (c), lines 6 and 7 ...................
of line 5 or line 8 ..................................Carryover of disallowed deduction from line 13 of your 2010 Form 4562 ..........................Business income limitation. Enter the smaller of business income (not less than zero) or line 5 (see instructions) .....Section 179 expense deduction. Add lines 9 and 10, but do not enter more than line 11 .................Carryover of disallowed deduction to 2012. Add lines 9 and 10, less line 12 ........
during the tax year (see instructions) ............................................Property subject to section 168(f)(1) election ........................................Other depreciation (including ACRS) ............................................
MACRS deductions for assets placed in service in tax years beginning before 2011 ....................
asset accounts, check here ............................................
Listed property. Enter amount from line 28 .......................................
and on the appropriate lines of your return. Partnerships and S corporations - see instructions ...........For assets shown above and placed in service during the current year, enter theportion of the basis attributable to section 263A costs .......................
See separate instructions. Attach to your tax return.
Note:
12345
789smaller101112
13Note:
(Do not
15 1516 16
(Do notSection A
17 1718
(b) (c)(a) (d) (e) (f) (g)
19 a
i
20 a
21
22
23For Paperwork Reduction Act Notice, see separate instructions. 4562
12345
(b) (c) (a)6
789
10111213
1414
Section B - Assets Placed in Service During 2011 Tax Year Using the General Depreciation System
bcdefgh
Section C - Assets Placed in Service During 2011 Tax Year Using the Alternative Depreciation System
bc
2122 Total.
23
(Including Information on Listed Property)
179
Election To Expense Certain Property Under Section 179
Special Depreciation Allowance and Other Depreciation
If you are electing to group any assets placed in service during the tax year into one or more general
Section A
183,,,,,,636MACRS deductions for assets placed in service in tax years beginning before 2011 .17 17
G
3,,,,,,,,781 I
Basic Income Tax Rental Income and Expenses 21-25
Nam
e:S
SN
:D
ate
Plac
ed
Om
Se
rvoc
e
Cos
tB
us %17
9Ex
pSp
ecia
lD
epr
Dep
rB
asis
Rec
ovPe
riod
Mth
dC
onv
Rec
over
edPr
ior Y
rs%
2010
Am
ount
%20
11A
mou
nt%
Am
ount
06/0
1/10
100.
0$1
00,0
0027
.5 y
rM
MS
/L1.
97$1
,970
3.63
6$3
,636
04/0
1/11
$725
100.
0$7
255
yrH
Y
200
DB
20.0
$145
Just
in C
ole
400-
00-1
800
Des
crip
tion
Tow
nhou
se
Ref
riger
ator
S/L
04/0
1/11
04/0
1/11
$725
$725
100.
010
00
$725
$725
5 yr
5H
Y
200
DB
20.0
200
$145
$145
Ref
riger
ator
Rfi
t
21-26 Rental Income and Expenses Basic Income Tax
If the taxpayer has more than three rental properties, complete and attach the required number of Schedules E to list all of the properties. If the taxpayer has more than three rental activities, see the Schedule EInstructions for more information.
Knowledge Check Five
1. Rental income or loss is calculated on which schedule?
Schedule A
Schedule C
Schedule D
Schedule E
2. A taxpayer should complete Form 4562 for a rental activity if they are claiming all but which one of the following?
Depreciation on property placed in service during the current year
Depreciation on any property that is listed property, regardless of when it was placed in service
Section 179 deduction
Any car expenses (using actual expenses or the standard mileage rate)
3. Ken rented out a residential investment property for 10 months and received net rental income of $3,488. Where is the income calculated and then reported?
Form 1040, Line 21
Schedule C, then Form 1040, Line 17
Schedule E, then Form 1040, Line 21
Schedule E, then Form 1040, Line 17
Basic Income Tax Rental Income and Expenses 21-27
Session 21 Summary Include advance rent and payment for cancellation of a lease as
rental income.
If a payment is called a security deposit and is intended to be the fi nal rent payment, it is advance rent and must be included in the taxpayer’s income when they receive it. Do not include a security deposit in income if it will be returned to the tenant at the end of the lease.
Instead of money, the taxpayer may receive property or services as rent. The FMV of the property or services rendered is considered rent.
If the taxpayer rents out their home for less than 15 days, do not include the rent as income and do not deduct rental expenses.
Rental expenses are the ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining rental property.
The expenses of maintaining rental property can be deducted, even if the property is vacant. The loss of rent while the property is vacant cannot be deducted.
Repairs keep the property in good operating condition and can be deducted in the year paid.
Improvements add to the value of the property, prolong the property’s useful life, or adapt the property to a new use. The cost of an improvement must be capitalized and generally can be depreciated as if the improvement is a separate property.
Other rental expenses that can be deducted from the gross rent include advertising, utilities, fi re and liability insurance, taxes, and interest.
The expenses of traveling away from home are deductible if the primary purpose of the trip is to collect rent or manage the rental property.
When a taxpayer’s home or other property is changed to rental use, they must allocate their costs, such as taxes and insurance, between rental and personal use. Rental expenses are only deducted for the time the property was in service as rental property.
Depreciation can be claimed on rental property based on the date placed in service. Land can never be depreciated.
The section 179 deduction cannot be claimed for assets purchased for use in a residential rental real estate property.
21-28 Rental Income and Expenses Basic Income Tax
The special depreciation allowance can be used if the property qualifi es under the general qualifi cations for the allowance.
Appliances, carpets, and furniture used in a rental property are depreciated over fi ve years.
Generally, rental real estate activities are considered passive activities and the amount of deductible loss may be limited.
Enter rent, expenses, and depreciation, and then calculate the taxpayer’s rental income or loss on Schedule E, Supplemental Income and Loss, Part I.
Complete Form 4562, Depreciation and Amortization, for rental activity only if the taxpayer is claiming at least one of the following:
Depreciation or amortization on property placed in service during the current year
Depreciation on listed property (such as a car), regardless of when it was placed in service
Any car expenses (using actual expenses or the standard mileage rate) not reported on Schedule C, Profi t or Loss From Business, or Schedule C-EZ, Net Profi t From Business
To document the depreciation taken each year, the taxpayer should use a depreciation worksheet. This helps calculate the basis for when they dispose of the property.
Basic Income Tax Rental Income and Expenses 21-29
Session 21 Homework1. Sam rented a room from Lisa on February 1, paying her $550
rent and a refundable security deposit of $250. He has a six-month lease with rent of $550 payable on the fi rst of each month. On April 29, he paid her $350 to cancel his lease and moved out. She returned his security deposit. How much rent must Lisa report on her tax return?
$900
$1,650
$2,000
$2,250
2. Chianti owns a house that she rented to Max for the entire year. She had the following expenses:
Connection to sewer system .................................$750
How much can Chianti deduct for rental expenses (without depreciation)?
$145
$895
$1,100
$1,245
3. Marco tried to sell his condo, but was unable to fi nd a buyer. In February, he began advertising for a tenant. He moved out of the condo on March 31 and fi nally found a tenant in August. Marco had the following expenses during the year:
Re-tiling the bathroom in May .............................$3,000
Real estate taxes ................................................$2,300
Homeowners’ association fees ...........................$2,000
Excluding depreciation, how much can Marco deduct for rental expenses?
$8,000
$9,000
$12,000
$17,000
21-30 Rental Income and Expenses Basic Income Tax
4. Micah owns a townhouse that he began renting out in 2008. He bought the townhouse in 2004 for $100,000 (excluding land value). The FMV when he began renting the property on April 1,2008 was $128,000 (excluding land value). Micah replaced all of the carpeting in the home during August of this year for $1,250. He would like to claim as much depreciation as he can. What is Micah’s depreciation deduction this year?
$4,386
$4,886
$103,750
$108,000
5. Clark’s fi ling status is MFJ. He purchased and placed into service a townhouse on March 30, 2006 for $265,000 (excluding land value). He had the following expenses this year:
Legal and professional services .........................$3,650
Clark earned $67,000 in wages and had gross rental income of $6,600. He actively participated in the rental activity. How much rental loss can Clark claim on his jointly-fi led return?
$9,635
$25,000
$26,435
$33,035
6. Anita rented her luxury condo out for 11 days during a convention held in her town. She received $3,200 rent for the rental period. Where will Anita report her rental income?
Form 1040, Line 21
Schedule C then Form 1040, Line 17
Schedule E then Form 1040, Line 17
The income is not reported.
Basic Income Tax Rental Income and Expenses 21-31
7. The Boswells rented out their residential investment property for two months. They received net rental income of $4,682. Where is this income reported?
Form 1040, Line 21
Schedule C, then Form 1040, Line 17
Schedule E, then Form 1040, Line 21
Schedule E, then Form 1040, Line 17
Partial Problem
Use the information provided to prepare Part I of Schedule E, Form 4562,and a depreciation worksheet for Naomi.
Naomi Sanai (11-26-1971, 400-00-1801), single
Current Address:123 Main StreetYour City, YS and ZIP Code
On September 24, 2010, she purchased a single-family home as rental property. The house cost $101,950, including a land value of $25,000.
Rental Property Address:412 Friendship LaneYour City, YS and ZIP Code
On the same day Naomi purchased the rental house, she had a new dishwasher installed for $378, and did not claim a special depreciation allowance. She had net income of $433 in the fi rst year.
Naomi received total rent of $8,400, and paid the following expenses during the year:
Naomi drove her car 540 miles to collect rent and check on her rental house during the fi rst half of the year. Her total mileage for the year was 12,486, 2,400 of which were commuting miles. She kept a log of her mileage.
Naomi has had the same car for six years and does not own another vehicle. She used the standard mileage rate last year.
21-32 Rental Income and Expenses Basic Income Tax
Basic Income Tax Rental Income and Expenses 21-33
Session 21 Knowledge Check Answers Use the following to verify your Knowledge Check responses.
Knowledge Check One
1. Refundable security deposit. Rent received includes advance rent, payments to cancel a lease, and expenses tenants pay for the taxpayer. Security deposits are not rent received if the taxpayer plans to return the deposit.
2. $900. Selena reports only the amount received for rent ($900). If the taxpayer intends to return a security deposit, it is not included in rent received.
3. $1,000. The value of repairs paid for by a tenant, that are usually the responsibility of the owner, is rent.
4. $500. The FMV of tenant services is rent. When the value is agreed upon in advance, that amount is considered the FMV.
5. $0. When a taxpayer’s home is rented for fewer than 15 days, the rent received is not included in income.
Knowledge Check Two
1. Ordinary and necessary. Rental expenses are the ordinary and necessary expenses for managing, conserving, or maintaining rental property.
2. Repairs. Deductible expenses include expenses for maintaining the property. Taxpayers may not deduct expenses for the part of the year the property is used for personal use, for improvements, or for lost rent while the property is vacant.
3. $3,450. Alyssa can deduct insurance, interest, and real estate taxes ($6,900) for the part of the year (50%) the property was used as a rental. Adding a sprinkler system is an improvement, and therefore not a deductible expense. ($6,900 × 0.50 = $3,450)
Knowledge Check Three
1. It is depreciable property with a 5-year recovery period. An appliance is a depreciable asset with a recovery period of fi ve years. Depreciation begins when property is placed in service. Section 179 is not allowed for residential rental property.
2. $3,830. The section 179 deduction cannot be claimed. John’s depreciation is calculated as follows: House $3,220 (27.5-year); refrigerator $170 (5-year); and carpet $440 (5-year). This year’s total depreciation is $3,830.
21-34 Rental Income and Expenses Basic Income Tax
Knowledge Check Four
1. Joshua lived in the house several years ago. Living in the house in the past does not limit the loss deduction. Losses may be limited for taxpayers who own less than a 10% interest, do not actively participate in the activity, and for taxpayers who live with their spouse, but fi le separately.
2. $100,000. The maximum amount of the special allowance for deducting rental losses is reduced if the taxpayer’s modifi ed AGI is more than $100,000.
Knowledge Check Five
1. Schedule E. Schedule E is used to calculate rental income or loss, and to report rental income received and expenses paid.
2. Section 179 deduction. The section 179 deduction is not available for residential rental property.
3. Schedule E, then Form 1040, Line 17. Ken’s net rental income is calculated and reported on Schedule E, and then reported on Form 1040, Line 17.
