Rental Income and Expenses at Tax Time

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

Landlords who keep detailed records of their rental property expenses are the ones who benefit the most at tax time. IRS rules regarding rental income are pretty generous, so you'll want to take advantage of them. Learn how to manage this part of your taxes.

Key Takeaways

  • To file your taxes on a rental property, you will need thorough records of all your income and expenses, including depreciation.
  • Rental properties are usually considered passive income.
  • If yours is considered active income, you may be able to deduct any rental losses up to $25,000 per year.
  • If you sell a rental property, you will need to subtract your cost basis from the selling price to find the profit, which is the income that is taxed.

Schedule E Tax Tips

Landlords must keep excellent records regarding cost basis, income, and expenses. The best way to track these items is to create a spreadsheet. Your tax accountant may even have a template you can use. Here are the items you'll want to track:

  • Purchase price of the house, condo, or apartment building you are renting out
  • Accumulated depreciation
  • Current annual depreciation on your property
  • Rental income
  • Security deposits you received

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

  • Commissions or property management fees
  • Advertising costs
  • Cleaning, maintenance, and repair costs
  • Homeowners insurance and HOA dues
  • Real estate taxes and mortgage interest expenses
  • Utilities

If you track these expenses using personal finance software or a computer spreadsheet, your monthly and year-end reports will be easy to compile and print.

Take Advantage of Passive Activity Loss Limitations

You may end the year with a net loss on a property. If you have more than one rental property, that loss can be netted against the losses and profits of all your others.

Now here's the maybe-not-so-good news: If the total for all your properties is negative—a net loss—that loss cannot usually be deducted from the rest of your annual income (but there are exceptions). That's because renting out real estate property is generally considered a passive activity.

Your rental income may be considered active if you devote a significant and real amount of time to making management decisions. These could include:

  • Selecting new tenants
  • Setting rental terms
  • Approving costs for repairs
  • Making repairs or hiring someone else to make repairs

If you actively participate in the rental activities, any rental losses can potentially be deducted up to $25,000 per year. This is a total value across all your rental properties. If you are married and file separate returns, you have a rental loss limit of up to $12,500, provided you lived apart from your spouse at all times during the tax year.

The amount of the rental loss allowed for active participants in a rental property varies based on your modified adjusted gross income (MAGI).

 Filing Status MAGI  Maximum Special Allowance
Individual or Head of Household $100,000 or less  $25,000
$100,001-$150,000 50% of the difference between $150,000 and MAGI
$150,000 or more No losses can be deducted against other income
Married Filing Jointly $100,000 or less  $25,000
$100,001-$150,000 50% of the difference between $150,000 and MAGI
$150,000 or more No losses can be deducted against other income
Married Filing Separately $50,000 or less $25,000
$50,001-$75,000 50% of the difference between $75,000 and MAGI
$75,000 or more No losses can be deducted against other income

You Can Carry Losses Forward

Rental losses that are limited by the passive activity loss limitations can be carried forward to the next tax year. At that point, they can offset your rental profits.

The passive activity loss limitations are applied each year. But rental losses continue to carry forward year after year until the losses are either used up by offsetting rental profits or by being deducted against other income.

Form 8582 is used to calculate passive activity loss limitations and to keep track of rental losses that accumulate each year for each property.

Tax Planning for Landlords

As a landlord, you can turn a profit when the income from a rental is enough to pay the mortgage as well as cover property taxes, insurance, and repairs. But you also get to depreciate the purchase price of the rental property. This can often turn an economic profit into a tax loss. Once you account for depreciation, your expenses may exceed your income.

Every so often, though, you may face major expenses. These could be replacing a roof or gutting an apartment after a long-term tenant vacates. As a result, you may have a loss greater than $25,000, but the passive activity loss rules limit the loss to exactly $25,000.

The remainder of your loss will be carried over to next year. At that point, you hopefully will have more of a profit. This will let you absorb the excess tax losses.

Selling Rental Properties

Selling a rental property is not the same as selling your primary residence. The formula for calculating the gain or loss of rental property involves subtracting your cost basis, or the initial price you paid, from your selling price. This allows you to find the profit you made, similar to calculating capital gains from an investment.

Adjusted Cost Basis for Rental Property

To find your cost basis on a rental property, you'll need to add a few different amounts. These are:

  • Purchase price
  • Purchase costs (title and escrow fees, real estate agent commissions, etc.)
  • Improvements (replacing the roof, new furnace, etc.)
  • Selling costs (title and escrow fees, real estate agent commissions, etc.)
  • Accumulated depreciation (as reported on your tax forms)

Added together, these equal your cost basis. Once you know your cost basis, you can subtract that from your selling price. If the result is positive, you made a profit when you sold your rental property. If the result is negative, you incurred a loss.

Gains on rental property sales can be taxed partly as depreciation recapture (at a maximum 25% tax rate) and partly as capital gains (which has a tax rate that depends on your overall income bracket). Rental property sales are reported on Form 4797, and any capital gain calculations are reported on Schedule D.

Real Property and Limited Liability

As a landlord, you might think about forming a corporation, limited liability company, or partnership to own your rental properties. But forming a corporation might hurt you at tax time. This is because favorable long-term capital gains rates only apply to individual taxpayers, not corporations.

A limited liability company, though, would be able to pass long-term gains through to its members. Since the gains are taxed on the members' personal tax returns, they're eligible for the preferred 15% rate on long-term gains.

Before you decide whether you need to form an LLC, partnership, or other entity, you should discuss it with an attorney. They will help you understand and plan for any legal and financial outcomes that would happen as a result.

Article Sources

  1. Internal Revenue Service. "Publication 527 Residential Rental Property (Including Rental of Vacation Homes)," Page 3.

  2. Internal Revenue Service. "Instructions for Schedule E," Pages 3-4.

  3. Internal Revenue Service. "Instructions for Form 8582, Passive Activity Loss Limitations: Rental Activities."

  4. Internal Revenue Service. "Instructions for Schedule E," Page 7-8.

  5. Internal Revenue Service. "Topic No. 425 Passive Activities - Losses and Credits."

  6. American Apartment Owners Association. "Calculating Gain on Sale of Rental Property."