If you're a landlord, it's important to understand Schedule E income. It's a form that you need to fill out to report your rental income or loss, royalties, and other types of income or loss related to partnerships, S corporations, estates, trusts, and real estate mortgage investments
Reporting Rental Property Income and Expenses
To report your rental income and expenses, use Schedule E for your rental property. Form 4562 is required for depreciation and amortization related to Schedule E, including a Section 179 expense election.
For hotel-like services, such as daily room cleaning or business rentals, report that income on Schedule C instead.
If you qualify as a real estate professional, you can report all rental income on Schedule C. You must meet two requirements: more than half of your services must be in real property trades, and you need to perform over 750 hours of services in those trades.
Offsetting Rental Losses with Passive Loss Rules
Keep in mind that rental losses may be limited under the passive loss rules, but there are exceptions that apply frequently.
If you or your spouse actively participate in the rental real estate activity, you can deduct up to $25000 rental loss despite the general passive loss limitations, and there's also an exception to the passive loss rules for real estate professionals.
You can be considered actively participating if you make important and management decisions like approving new tenants, setting rental rates, giving the green light for expenses, and other such choices
Let's break down an example to help you understand how you can use losses from rental real estate activities to offset your income.
You make $70,000 from W2, $15000 income limited partnership, a $20,000 loss from rental real estate activities. If you actively participated in your rental real estate activities, you can use the remaining $11,000 rental real estate loss to offset $11,000 of your nonpassive income (wages). Boom, there you have it!
Other Rental Income/Expense Considerations
Rental income may also be subject to the 3.8% net investment income tax when rental income is basically a passive activity. Payments under a rental agreement that also give the tenant an option to buy are generally considered rental income, prior to any actual exercise of an option to buy.
Security deposits are generally not income, although forfeitures of such deposits constitute income. Lease cancellation payments are rental income to the owner, and services by the tenant, such as painting the property in lieu of some rent, translate into rental income.
If you've converted a former home to a rental property, the basis for depreciating the realty is the lower of fair market value or adjusted basis on the date of the conversion. Any prior depreciation would reduce the adjusted basis. Land is not depreciable, so if you provide a lump-sum purchase price, the tax professional will need to reasonably allocate a portion to the residence/structural and land components.
If you've received a residential property by gift, the basis is usually a carryover basis if the fair market value equals or exceeds the donor’s adjusted basis on the date the gift is received. If a decedent passed a residential property to a beneficiary/heir at death, the property would have a basis for income tax purposes equal to fair market value at the time of the decedent’s death.
Partial Rental Use and Rental Losses
When it comes to personal vs. rental use, partial rental use triggers rental expense allocations requiring total expenses to be multiplied by the ratio of the number of rental days at a fair rental to total days of use to determine the deductible portion. There's a special rule if you used the dwelling unit as a home and rented it for less than 15 days during the year. Rental losses may be challenged for lack of a profit motive in unusual circumstances, such as short-term rentals prior to a move. Consult with a tax professional to ensure you're correctly reporting your rental income and expenses.