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Rental Income & Expenses at The Time of Taxation

Rental Income & Expenses at The Time of Taxation

If you have rental property income, you will need to file the Internal Revenue Service (IRS) Schedule E ("Supplement Income and Losses") for landlords. The key to doing this quickly and smoothly is to organize your income and expenses using a spreadsheet or personal finance software.

Landlords who keep detailed records of rental expenses will benefit the most at tax time. The IRS rules on rental income are quite generous, so you'll want to take advantage of them.


Schedule E Tax Advice

Owners should keep excellent records of costs, income, and expenses. The best way to keep track of these items is to create a spreadsheet. Your accountant may also have a template you can use. Here are the things you want to monitor:

  • Accumulated Depreciation

  • Amount of income

  • Current annual depreciation of your property

  • Security deposits you have received

  • The purchase price of the house, apartment, or condominium you are renting out

In addition to tracking your income, you'll want to keep track of your expenses. Many expenses related to maintaining a rental property can be deducted from rental income. These expenses include:

  • Advertising costs

  • Cleaning, maintenance, and repair costs

  • Home insurance and HOA taxes

  • Property management fees or charges

  • Property taxes and mortgage interest charges

  • Utilities

If you track these expenses using personal finance software or a computer spreadsheet, your monthly and annual reports are easy to complete and print.


Take advantage of passive activity loss limits.

You can end the year with a net loss on a property. If you have more than one rental property, this loss may be offset by the gains and losses of all the others.

Now here's the good news: if the total of all your assets is negative (a net loss), that loss generally cannot be deducted from the rest of your annual income (but there are exceptions). Real estate leasing is generally considered a passive asset.

Your rental income can be considered an asset if you spend significant, real-time making management decisions. These may include:

  • Approval of repair costs

  • Define rental conditions

  • Make repairs or hire someone else to do them

  • Selection of new tenants

If you are actively involved in the rental business, any rental losses can be deducted up to $25,000 per year. This is a total for all of your rental properties. If you are married and filing separately, you are limited to a loss of rent of up to $12,500, provided you have lived apart from your spouse throughout the tax year.

The amount of eligible rent loss for active participants in a leased property varies according to their modified adjusted gross income (MAGI).


You can carry losses forward.

Rental losses limited by restrictions on the loss of liabilities can be carried forward to the next year. At that time, they can offset your rental profits. 

The passive activity loss limitations apply annually. However, rental losses continue year after year until the losses are exhausted by offsetting rental income or deduction other income.

Form 8582 is used to calculate loss liabilities and to track rental losses accrued each year for each property.


Tax planning for Landlords

As a landlord, you can take advantage of this when your rental income is sufficient to pay your mortgage and cover property taxes, insurance, and repairs. But it can also lead to a depreciation of the purchase price of the rental property. This can often turn a financial gain into a tax loss. Once you've accounted for depreciation, your expenses may exceed your income.

However, from time to time, you may incur significant expenses. It can be the replacement of a roof or gutting of an apartment following the release of a long-term tenant. As a result, you may have a loss of more than $25,000, but the liability loss rules limit the loss to exactly $25,000.

The rest of your loss will carry over to next year. At this time, we expect you to earn more. This will allow you to absorb excess tax losses.


Sale of rental properties

Selling a rental property is not the same as selling your principal residence. The formula for calculating profit or loss on your rental property is to deduct the base or original price you paid from your selling price. This allows you to find the profit you are looking for, similar to the rental profit calculation.


Adjusted cost basis for real estate rentals

To find the base price of a rental property, you will need to add a few different values. These are:

  • Buying price

  • Purchase costs (bond and escrow fees, real estate agent fees, etc.)

  • Improvements (roof replacement, new oven, etc.)

  • Selling costs (deposits and bond commissions, estate agent commissions, etc.)

  • Accumulated depreciation (as shown on tax forms)

Added together, they correspond to your cost base. Once you know your base price, you can subtract it from the sale price. If the result is positive, you have made a profit by selling the leased property. If the result is negative, you have suffered a loss.

Gains from leased property sale may be taxed partly as a recapture of depreciation (at a maximum rate of 25%) and partly as capital gains (the tax rate of which depends on the level of general income). Sales of leased property are reported on Form 4797, and any capital gains calculations are reported on Schedule D.


Real Property and limited liability

As a landlord, you may want to consider forming a corporation, limited liability company, or partnership to own your rental property. But setting up a corporation can hurt you at tax time. This is because favorable long-term capital gains rates only apply to individual taxpayers, not corporations.

However, a limited liability company can pass on long-term profits to its members. Since income is taxed on members' tax returns, they are eligible for the 15% long-term compensation rate.

Before forming an LLC, partnership, or other entity, consult an attorney. They will help you understand and plan for the legal and financial outcomes that may arise.


Summary

  • If you sell a leased property, you will need to deduct the cost base from the sale price to find the taxable income profit.

  • If your income is considered active, you can deduct rent losses up to $25,000 per year.

  • Rental properties are generally considered passive income.

  • To file taxes on a rental property, you will need complete records of all your income and expenses, including depreciation.


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