9. Rental Income and Expenses
Table of Contents
* Introduction
* Useful Items - You may want to see:
* Rental Income
* Rental Expenses
o Repairs and Improvements
o Other Expenses
* Not Rented for Profit
* Property Changed to Rental Use
* Renting Part of Property
* Personal Use of Dwelling Unit (Including Vacation Home)
o Dwelling Unit Used as Home
o Figuring Days of Personal Use
o How To Divide Expenses
o How To Figure Rental Income and Deductions
* Depreciation
o Changing your accounting method to deduct unclaimed depreciation.
o Other Rules About Depreciable Property
* Limits on Rental Losses
o At-Risk Rules
o Passive Activity Limits
* How To Report Rental Income and Expenses
o Schedule E (Form 1040)
Introduction
This chapter discusses rental income and expenses. It covers the following
topics.
*
Rental income.
*
Rental expenses.
*
Personal use of dwelling unit (including vacation home).
*
Depreciation.
*
Limits on rental losses.
*
How to report your rental income and expenses.
If you sell or otherwise dispose of your rental property, see Publication
544, Sales and Other Dispositions of Assets.
If you have a loss from damage to, or theft of, rental property, see
Publication 547, Casualties, Disasters, and Thefts.
If you rent a condominium or a cooperative apartment, some special rules
apply to you even though you receive the same tax treatment as other owners
of rental property. See Publication 527, Residential Rental Property, for
more information.
Useful Items - You may want to see:
Publication
*
527 Residential Rental Property
*
534 Depreciating Property Placed in Service Before 1987
*
535 Business Expenses
*
925 Passive Activity and At-Risk Rules
*
946 How To Depreciate Property
Form (and Instructions)
*
4562
Depreciation and Amortization
*
6251
Alternative Minimum Tax—Individuals
*
8582
Passive Activity Loss Limitations
*
Schedule E (Form 1040)
Supplemental Income and Loss
Rental Income
You generally must include in your gross income all amounts you receive as
rent. Rental income is any payment you receive for the use or occupation of
property. In addition to amounts you receive as normal rent payments, there
are other amounts that may be rental income.
When to report. If you are a cash basis taxpayer, report rental income on
your return for the year you actually or constructively receive it. You are
a cash basis taxpayer if you report income in the year you receive it,
regardless of when it was earned. You constructively receive income when it
is made available to you, for example, by being credited to your bank account.
For more information about when you constructively receive income, see
Accounting Methods in chapter 1.
Advance rent. Advance rent is any amount you receive before the period
that it covers. Include advance rent in your rental income in the year you
receive it regardless of the period covered or the method of accounting you
use.
Example.
You sign a 10-year lease to rent your property. In the first year, you
receive $5,000 for the first year's rent and $5,000 as rent for the last
year of the lease. You must include $10,000 in your income in the first year.
Security deposits. Do not include a security deposit in your income when
you receive it if you plan to return it to your tenant at the end of the
lease. But if you keep part or all of the security deposit during any year
because your tenant does not live up to the terms of the lease, include the
amount you keep in your income for that year.
If an amount called a security deposit is to be used as a final payment
of rent, it is advance rent. Include it in your income when you receive it.
Payment for canceling a lease. If your tenant pays you to cancel a lease,
the amount you receive is rent. Include the payment in your income in the
year you receive it regardless of your method of accounting.
Expenses paid by tenant. If your tenant pays any of your expenses, the
payments are rental income. You must include them in your income. You can
deduct the expenses if they are deductible rental expenses. See Rental
Expenses, later, for more information.
Property or services. If you receive property or services, instead of
money, as rent, include the fair market value of the property or services
in your rental income.
If the services are provided at an agreed upon or specified price, that
price is the fair market value unless there is evidence to the contrary.
Rental of property also used as a home. If you rent property that you
also use as your home and you rent it fewer than 15 days during the tax
year, do not include the rent you receive in your income and do not deduct
rental expenses. However, you can deduct on Schedule A (Form 1040) the
interest, taxes, and casualty and theft losses that are allowed for
nonrental property. See Personal Use of Dwelling Unit (Including Vacation
Home), later.
Part interest. If you own a part interest in rental property, you must
report your part of the rental income from the property.
Rental Expenses
This part discusses expenses of renting property that you ordinarily can
deduct from your rental income. It includes information on the expenses you
can deduct if you rent part of your property, or if you change your
property to rental use. Depreciation, which you can also deduct from your
rental income, is discussed later.
When to deduct. You generally deduct your rental expenses in the year you
pay them.
Vacant rental property. If you hold property for rental purposes, you may
be able to deduct your ordinary and necessary expenses (including
depreciation) for managing, conserving, or maintaining the property while
the property is vacant. However, you cannot deduct any loss of rental
income for the period the property is vacant.
Pre-rental expenses. You can deduct your ordinary and necessary expenses
for managing, conserving, or maintaining rental property from the time you
make it available for rent.
Depreciation. You can begin to depreciate rental property when it is
ready and available for rent. See Placed-in-Service Date under
Depreciation, in Publication 527.
Expenses for rental property sold. If you sell property you held for
rental purposes, you can deduct the ordinary and necessary expenses for
managing, conserving, or maintaining the property until it is sold.
Personal use of rental property. If you sometimes use your rental
property for personal purposes, you must divide your expenses between
rental and personal use. Also, your rental expense deductions may be
limited. See Personal Use of Dwelling Unit (Including Vacation Home), later.
Part interest. If you own a part interest in rental property, you can
deduct your part of the expenses that you paid.
Uncollected rent. If you are a cash basis taxpayer, you do not report
uncollected rent. Because you do not include it in your income, you cannot
deduct it.
If you use an accrual method, you report income when you earn it. If you
are unable to collect the rent, you may be able to deduct it as a business
bad debt. See chapter 11 of Publication 535 for more information about
business bad debts.
Repairs and Improvements
You can deduct the cost of repairs to your rental property. You cannot
deduct the cost of improvements. You recover the cost of improvements by
taking depreciation (explained later).
Records you should keep
Separate the costs of repairs and improvements, and keep accurate records.
You will need to know the cost of improvements when you sell or depreciate
your property.
Repairs. A repair keeps your property in good operating condition. It
does not materially add to the value of your property or substantially
prolong its life. Repainting your property inside or out, fixing gutters or
floors, fixing leaks, plastering, and replacing broken windows are examples
of repairs.
If you make repairs as part of an extensive remodeling or restoration of
your property, the whole job is an improvement.
Improvements. An improvement adds to the value of property, prolongs its
useful life, or adapts it to new uses. Improvements include the following
items.
*
Putting a recreation room in an unfinished basement.
*
Paneling a den.
*
Adding a bathroom or bedroom.
*
Putting decorative grillwork on a balcony.
*
Putting up a fence.
*
Putting in new plumbing or wiring.
*
Putting in new cabinets.
*
Putting on a new roof.
*
Paving a driveway.
If you make an improvement to property, the cost of the improvement must
be capitalized. The capitalized cost can generally be depreciated as if the
improvement were separate property.
Other Expenses
Other expenses you can deduct from your rental income include advertising,
cleaning and maintenance, utilities, fire and liability insurance, taxes,
interest, commissions for the collection of rent, ordinary and necessary
travel and transportation, and other expenses, discussed next.
Rental payments for property. You can deduct the rent you pay for
property that you use for rental purposes. If you buy a leasehold for
rental purposes, you can deduct an equal part of the cost each year over
the term of the lease.
Rental of equipment. You can deduct the rent you pay for equipment that
you use for rental purposes. However, in some cases, lease contracts are
actually purchase contracts. If so, you cannot deduct these payments. You
can recover the cost of purchased equipment through depreciation.
Insurance premiums paid in advance. If you pay an insurance premium for
more than one year in advance, each year you can deduct the part of the
premium payment that will apply to that year. You cannot deduct the total
premium in the year you pay it.
Local benefit taxes. Generally, you cannot deduct charges for local
benefits that increase the value of your property, such as charges for
putting in streets, sidewalks, or water and sewer systems. These charges
are nondepreciable capital expenditures. You must add them to the basis of
your property. You can deduct local benefit taxes if they are for
maintaining, repairing, or paying interest charges for the benefits.
Travel expenses. You can deduct the ordinary and necessary expenses of
traveling away from home if the primary purpose of the trip was to collect
rental income or to manage, conserve, or maintain your rental property. You
must properly allocate your expenses between rental and nonrental
activities. You cannot deduct the cost of traveling away from home if the
primary purpose of the trip was the improvement of your property. You
recover the cost of improvements by taking depreciation. For information on
travel expenses, see chapter 26.
Records you should keep
To deduct travel expenses, you must keep records that follow the rules in
chapter 26.
Local transportation expenses. You can deduct your ordinary and
necessary local transportation expenses if you incur them to collect rental
income or to manage, conserve, or maintain your rental property.
Generally, if you use your personal car, pickup truck, or light van for
rental activities, you can deduct the expenses using one of two methods:
actual expenses or the standard mileage rate. For 2005, the standard
mileage rate for all business miles driven before September 1 is 40½ cents
a mile. The rate is 48½ cents a mile for all business miles driven after
August 31. For more information, see chapter 26.
Records you should keep
To deduct car expenses under either method, you must keep records that
follow the rules in chapter 26. In addition, you must complete Form 4562,
Part V, and attach it to your tax return.
Tax return preparation. You can deduct, as a rental expense, the part of
the tax return preparation fees you paid to prepare Schedule E (Form 1040),
Part I. For example, on your 2005 Schedule E, you can deduct fees paid in
2005 to prepare your 2004 Schedule E, Part I. You can also deduct, as a
rental expense, any expense (other than federal taxes and penalties) you
paid to resolve a tax underpayment related to your rental activities.
Not Rented for Profit
If you do not rent your property to make a profit, you can deduct your
rental expenses only up to the amount of your rental income. You cannot
carry forward to the next year any rental expenses that are more than your
rental income for the year. For more information about the rules for an
activity not engaged in for profit, see chapter 1 of Publication 535.
Where to report. Report your not-for-profit rental income on Form 1040,
line 21. You can include your mortgage interest (if you use the property as
your main home or second home), real estate taxes, and casualty losses on
the appropriate lines of Form 1040, Schedule A, Itemized Deductions, if you
itemize your deductions.
Claim your other rental expenses, subject to the rules explained in
chapter 1 of Publication 535, as miscellaneous itemized deductions on Form
1040, Schedule A, line 22. You can deduct these expenses only if they,
together with certain other miscellaneous itemized deductions, total more
than 2% of your adjusted gross income.
Property Changed to Rental Use
If you change your home or other property, (or a part of it), to rental use
at any time other than at the beginning of your tax year, you must divide
yearly expenses, such as taxes and insurance, between rental use and
personal use.
You can deduct as rental expenses only the part of the expense that is for
the part of the year the property was used or held for rental purposes.
For depreciation purposes, treat the property as being placed in service on
the conversion date.
You cannot deduct depreciation or insurance for the part of the year the
property was held for personal use. However, you can include the home
mortgage interest and real estate tax expenses for the part of the year the
property was held for personal use as an itemized deduction on Schedule A
(Form 1040).
Example.
Your tax year is the calendar year. You moved from your home in May and
started renting it on June 1. You can deduct as rental expenses
seven-twelfths of your yearly expenses, such as taxes and insurance.
Starting with June, you can deduct as rental expenses the amounts you pay
for items generally billed monthly, such as utilities.
Renting Part of Property
If you rent part of your property, you must divide certain expenses between
the part of the property used for rental purposes and the part of the
property used for personal purposes, as though you actually had two
separate pieces of property.
You can deduct the expenses related to the part of the property used for
rental purposes, such as home mortgage interest and real estate taxes, as
rental expenses on Schedule E (Form 1040). You can also deduct as a rental
expense a part of other expenses that normally are nondeductible personal
expenses, such as expenses for electricity or painting the outside of your
house.
You can deduct the expenses for the part of the property used for personal
purposes, subject to certain limitations, only if you itemize your
deductions on Schedule A (Form 1040).
You cannot deduct any part of the cost of the first phone line even if your
tenants have unlimited use of it.
You do not have to divide the expenses that belong only to the rental part
of your property. For example, if you paint a room that you rent, or if you
pay premiums for liability insurance in connection with renting a room in
your home, your entire cost is a rental expense. If you install a second
phone line strictly for your tenants' use, all of the cost of the second
line is deductible as a rental expense. You can deduct depreciation,
discussed later, on the part of the property used for rental purposes as
well as on the furniture and equipment you use for rental purposes.
How to divide expenses. If an expense is for both rental use and personal
use, such as mortgage interest or heat for the entire house, you must
divide the expense between the rental use and the personal use. You can use
any reasonable method for dividing the expense. It may be reasonable to
divide the cost of some items (for example, water) based on the number of
people using them. However, the two most common methods for dividing an
expense are one based on the number of rooms in your home and one based on
the square footage of your home.
Personal Use of Dwelling Unit (Including Vacation Home)
If you have any personal use of a dwelling unit (including a vacation home)
that you rent, you must divide your expenses between rental use and
personal use. See Figuring Days of Personal Use and How To Divide Expenses,
later.
If you used your dwelling unit for personal purposes, it may be considered
a “dwelling unit used as a home.” If it is, you cannot deduct rental
expenses that are more than your rental income for the unit. See Dwelling
Unit Used as Home and How To Figure Rental Income and Deductions, later. If
your dwelling unit is not considered a dwelling unit used as a home, you
can deduct rental expenses that are more than rental income for the unit
subject to certain limits. See Limits on Rental Losses, later.
Exception for minimal rental use. If you use the dwelling unit as a home
and you rent it fewer than 15 days during the year, do not include any of
the rent in your income and do not deduct any of the rental expenses. To
determine if you use a dwelling unit as a home, see Dwelling Unit Used as
Home, later.
Dwelling unit. A dwelling unit includes a house, apartment, condominium,
mobile home, boat, vacation home, or similar property. A dwelling unit has
basic living accommodations, such as sleeping space, a toilet, and cooking
facilities. A dwelling unit does not include property used solely as a
hotel, motel, inn, or similar establishment.
Property is used solely as a hotel, motel, inn, or similar establishment
if it is regularly available for occupancy by paying customers and is not
used by an owner as a home during the year.
Example.
You rent a room in your home that is always available for short-term
occupancy by paying customers. You do not use the room yourself, and you
allow only paying customers to use the room. The room is used solely as a
hotel, motel, inn, or similar establishment and is not a dwelling unit.
Dwelling Unit Used as Home
The tax treatment of rental income and expenses for a dwelling unit that
you also use for personal purposes depends on whether you use it as a home.
(See How To Figure Rental Income and Deductions, later.)
You use a dwelling unit as a home during the tax year if you use it for
personal purposes more than the greater of:
1.
14 days, or
2.
10% of the total days it is rented to others at a fair rental price.
See Figuring Days of Personal Use, later.
If a dwelling unit is used for personal purposes on a day it is rented at a
fair rental price, do not count that day as a day of rental use in applying
(2) above. Instead, count it as a day of personal use in applying both (1)
and (2) above. This rule does not apply when dividing expenses between
rental and personal use.
Fair rental price. A fair rental price for your property generally is the
amount of rent that a person who is not related to you would be willing to
pay. The rent you charge is not a fair rental price if it is substantially
less than the rents charged for other properties that are similar to your
property.
Examples
The following examples show how to determine whether you used your rental
property as a home.
Example 1.
You converted the basement of your home into an apartment with a bedroom, a
bathroom, and a small kitchen. You rented the basement apartment at a fair
rental price to college students during the regular school year. You rented
to them on a 9-month lease (273 days). You figured 10% of the total days
rented to others at a fair rental price is 27 days.
During June (30 days), your brother stayed with you and lived in the
basement apartment rent free.
Your basement apartment was used as a home because you used it for personal
purposes for 30 days. Rent-free use by your brother is considered personal
use. Your personal use (30 days) is more than the greater of 14 days or 10%
of the total days it was rented (27 days).
Example 2.
You rented the guest bedroom in your home at a fair rental price during the
local college's homecoming, commencement, and football weekends (a total of
27 days). Your sister-in-law stayed in the room, rent free, for the last 3
weeks (21 days) in July. You figured 10% of the total days rented to others
at a fair rental price is 3 days.
The room was used as a home because you used it for personal purposes for
21 days. That is more than the greater of 14 days or 10% of the 27 days it
was rented (3 days).
Example 3.
You own a condominium apartment in a resort area. You rented it at a fair
rental price for a total of 170 days during the year. For 12 of those days,
the tenant was not able to use the apartment and allowed you to use it even
though you did not refund any of the rent. Your family actually used the
apartment for 10 of those days. Therefore, the apartment is treated as
having been rented for 160 (170 - 10) days. You figure 10% of the total
days rented to others at a fair rental price is 16 days. Your family also
used the apartment for 7 other days during the year.
You used the apartment as a home because you used it for personal purposes
for 17 days. That is more than the greater of 14 days or 10% of the 160
days it was rented (16 days).
Use As Main Home Before or After Renting
For purposes of determining whether a dwelling unit was used as a home, you
may not have to count days you used the property as your main home before
or after renting it or offering it for rent as days of personal use. Do not
count them as days of personal use if:
*
You rented or tried to rent the property for 12 or more consecutive
months.
*
You rented or tried to rent the property for a period of less than 12
consecutive months and the period ended because you sold or exchanged the
property.
This special rule does not apply when dividing expenses between rental and
personal use.
Figuring Days of Personal Use
A day of personal use of a dwelling unit is any day that the unit is used
by any of the following persons.
1.
You or any other person who has an interest in it, unless you rent it
to another owner as his or her main home under a shared equity financing
agreement (defined later). However, see Use as Main Home Before or After
Renting under Dwelling Unit Used As Home, earlier.
2.
A member of your family or a member of the family of any other person
who has an interest in it, unless the family member uses the dwelling unit
as his or her main home and pays a fair rental price. Family includes only
brothers and sisters, half-brothers and half-sisters, spouses, ancestors
(parents, grandparents, etc.) and lineal descendants (children,
grandchildren, etc.).
3.
Anyone under an arrangement that lets you use some other dwelling unit.
4.
Anyone at less than a fair rental price.
Main home. If the other person or member of the family in (1) or (2)
above has more than one home, his or her main home is ordinarily the one he
or she lived in most of the time.
Shared equity financing agreement. This is an agreement under which two
or more persons acquire undivided interests for more than 50 years in an
entire dwelling unit, including the land, and one or more of the co-owners
is entitled to occupy the unit as his or her main home upon payment of rent
to the other co-owner or owners.
Donation of use of property. You use a dwelling unit for personal
purposes if:
*
You donate the use of the unit to a charitable organization,
*
The organization sells the use of the unit at a fund-raising event, and
*
The “purchaser” uses the unit.
Examples
The following examples show how to determine days of personal use.
Example 1.
You and your neighbor are co-owners of a condominium at the beach. You rent
the unit to vacationers whenever possible. The unit is not used as a main
home by anyone. Your neighbor uses the unit for 2 weeks every year.
Because your neighbor has an interest in the unit, both of you are
considered to have used the unit for personal purposes during those 2 weeks.
Example 2.
You and your neighbors are co-owners of a house under a shared equity
financing agreement. Your neighbors live in the house and pay you a fair
rental price.
Even though your neighbors have an interest in the house, the days your
neighbors live there are not counted as days of personal use by you. This
is because your neighbors rent the house as their main home under a shared
equity financing agreement.
Example 3.
You own a rental property that you rent to your son. Your son has no
interest in this property. He uses it as his main home. He pays you a fair
rental price for the property.
Your son's use of the property is not personal use by you because your son
is using it as his main home, he has no interest in the property, and he is
paying you a fair rental price.
Example 4.
You rent your beach house to Joshua. Joshua rents his house in the
mountains to you. You each pay a fair rental price.
You are using your house for personal purposes on the days that Joshua uses
it because your house is used by Joshua under an arrangement that allows
you to use his house.
Days Used for Repairs and Maintenance
Any day that you spend working substantially full time repairing and
maintaining (not improving) your property is not counted as a day of
personal use. Do not count such a day as a day of personal use even if
family members use the property for recreational purposes on the same day.
How To Divide Expenses
If you use a dwelling unit for both rental and personal purposes, divide
your expenses between the rental use and the personal use based on the
number of days used for each purpose. You can deduct expenses for the
rental use of the unit under the rules explained in How To Figure Rental
Income and Deductions, later.
When dividing your expenses follow these rules.
*
Any day that the unit is rented at a fair rental price is a day of
rental use even if you used the unit for personal purposes that day. This
rule does not apply when determining whether you used the unit as a home.
*
Any day that the unit is available for rent but not actually rented
is not a day of rental use.
Example.
Your beach cottage was available for rent from June 1 through August 31 (92
days). Your family uses the cottage during the last 2 weeks in May (14
days). You were unable to find a renter for the first week in August (7
days). The person who rented the cottage for July allowed you to use it
over a weekend (2 days) without any reduction in or refund of rent. The
cottage was not used at all before May 17 or after August 31.
You figure the part of the cottage expenses to treat as rental expenses as
follows.
1.
The cottage was used for rental a total of 85 days (92 - 7). The days
it was available for rent but not rented (7 days) are not days of rental
use. The July weekend (2 days) you used it is rental use because you
received a fair rental price for the weekend.
2.
You used the cottage for personal purposes for 14 days (the last 2
weeks in May).
3.
The total use of the cottage was 99 days (14 days personal use + 85
days rental use).
4.
Your rental expenses are 85/99 (86%) of the cottage expenses.
When determining whether you used the cottage as a home, the July weekend
(2 days) you used it is personal use even though you received a fair rental
price for the weekend. Therefore, you had 16 days of personal use and 83
days of rental use for this purpose. Because you used the cottage for
personal purposes more than 14 days and more than 10% of the days of rental
use (8 days), you used it as a home. If you have a net loss, you may not be
able to deduct all of the rental expenses. See Property Used as a Home in
the following discussion.
How To Figure Rental Income and Deductions
How you figure your rental income and deductions depends on whether you
used the dwelling unit as a home (see Dwelling Unit Used as Home, earlier)
and, if you used it as a home, how many days the property was rented at a
fair rental price.
Property Not Used as a Home
If you do not use a dwelling unit as a home, report all the rental income
and deduct all the rental expenses. See How To Report Rental Income and
Expenses, later.
Your deductible rental expenses can be more than your gross rental income.
However, see Limits on Rental Losses, later.
Worksheet 9-1. Worksheet for Figuring the Limit on Rental Deductions for a
Dwelling unit Used as a Home
Use this worksheet only if you answer “yes” to all the following questions.
*
Did you use the dwelling unit as a home this year? (See Dwelling Unit
Used as Home.)
*
Did you rent the dwelling unit 15 days or more this year?
*
Is the total or your rental expenses and depreciation more than your
rental income?
1. Enter rents received
2a. Enter the rental portion of deductible home mortgage interest (see
instructions)
b. Enter the rental portion of real estate taxes
c. Enter the rental portion of deduction casualty and theft losses (see
instructions)
d. Enter direct rental expenses (see instructions)
e. Fully deductible rental expenses. Add lines 2a-2d
3. Subtract line 2e from line 1. If zero or less, enter zero
4a. Enter the rental portion of expenses directly related to operating or
maintaining the dwelling unit (such as repairs, insurance, and utilities)
b. Enter the rental portion of excess mortgage interest (see
instructions)
c. Add lines 4a and 4b
d. Allowable expenses. Enter the smaller of line 3 or line 4c
5. Subtract line 4d fro line 3. If zero or less, enter zero
6a. Enter the rental portion of excess casualty and theft losses (see
instructions)
b. Enter the rental portion of depreciation of the dwelling unit
c. Add lines 6a and 6b
d. Allowable excess casualty and theft losses and depreciation. Enter the
smaller of line 5 or line 6c
7a. Operating expenses to be carried over to next year. Subtract line 4d
from line 4c
b. Excess casualty and theft losses and depreciation to be carried over to
next year. Subtract line 6d from line 6c
Enter the amounts on lines 2e, 4d, and 6d on the appropriate lines of
Schedule E (Form 1040), Part I.
Worksheet Instructions
Follow these instructions for the worksheet above. If you were unable to
deduct all your expenses last year, because of the rental income limit, add
these unused amounts to your expenses for this year.
Line 2a. Figure the mortgage interest on the dwelling unit that you could
deduct on Schedule A (Form 1040) if you had not rented the unit. Do not
include interest on a loan that did not benefit the dwelling unit. For
example, do not include interest on a home equity loan used to pay off
credit cards or other personal loans, buy a car, or pay college tuition.
Include interest on a loan used to buy, build, or improve the dwelling
unit, or to refinance such a loan. Enter the rental portion of this
interest on line 2a of the worksheet.
Line 2c. Figure the casualty and theft losses related to the dwelling unit
that you could deduct on Schedule A (Form 1040) if you had not rented the
dwelling unit. To do this, complete Form 4684, Casualties and Thefts,
Section A, treating the losses as personal losses. On Form 4684, line 19,
enter 10% of your adjusted gross income figured without your rental income
and expenses from the dwelling unit. If your loss occurred after August 24,
2005, and was the result of Hurricane Katrina, enter zero on line 19. Enter
the rental portion of the result from Form 4684, line 18, on line 2c of
this worksheet.
Note. Do not file this Form 4684 or use it to figure your personal losses
on Schedule A. Instead, figure the personal portion on a separate Form 4684.
Line 2d. Enter the total of your rental expenses that are directly related
only to the rental activity. These include interest on loans used for
rental activities other than to buy, build, or improve the dwelling unit.
Also include rental agency fees, advertising, office supplies, and
depreciation on office equipment used in your rental activity.
Line 4b. On line 2a, you entered the rental portion of the mortgage
interest you could deduct on Schedule A if you had not rented the dwelling
unit. Enter on line 4b of this worksheet the rental portion of the mortgage
interest you could not deduct on Schedule A because it is more than the
limit on home mortgage interest. Do not include interest on a loan that did
not benefit the dwelling unit (as explained in the line 2a instructions).
Line 6a. To find the rental portion of excess casualty and theft losses,
use the Form 4684 you prepared for line 2c of this worksheet.
A. Enter the amount from Form 4684, line 10
B. Enter the rental portion of A
C. Enter the amount from line 2c of this worksheet
D. Subtract C from B. Enter the result here and on line 6a of this
worksheet
Allocating the limited deduction. If you cannot deduct all of the amount on
line 4c or 6c this year, you can allocate the allowable deduction in any
way you wish among the expenses included on line 4c or 6c. Enter the amount
you allocate to each expense on the appropriate line of Schedule E, Part I.
Property Used as a Home
If you use a dwelling unit as a home during the year (see Dwelling Unit
Used as Home, earlier), how you figure your rental income and deductions
depends on how many days the unit was rented at a fair rental price.
Rented fewer than 15 days. If you use a dwelling unit as a home and you
rent it fewer than 15 days during the year, do not include any rental
income in your income. Also, you cannot deduct any expenses as rental expenses.
Rented 15 days or more. If you use a dwelling unit as a home and rent it
15 days or more during the year, you include all your rental income in your
income. See How To Report Rental Income and Expenses, later. If you had a
net profit from the rental property for the year (that is, if your rental
income is more than the total of your rental expenses, including
depreciation), deduct all of your rental expenses. However, if you had a
net loss, your deduction for certain rental expenses is limited.
Use Worksheet 9-1 to figure your deductible expenses.
Depreciation
You recover your cost in income producing property through yearly tax
deductions. You do this by depreciating the property; that is, by deducting
some of the cost on your tax return each year.
Three basic factors determine how much depreciation you can deduct. They
are: (1) your basis in the property, (2) the recovery period for the
property, and (3) the depreciation method used. You cannot simply deduct
your mortgage or principal payments, or the cost of furniture, fixtures and
equipment, as an expense.
You can deduct depreciation only on the part of your property used for
rental purposes. Depreciation reduces your basis for figuring gain or loss
on a later sale or exchange.
You may have to use Form 4562 to figure and report your depreciation. See
How To Report Rental Income and Expenses, later.
Claiming the correct amount of depreciation. You should claim the correct
amount of depreciation each tax year. Even if you did not claim
depreciation that you were entitled to deduct, you must still reduce your
basis in the property by the full amount of depreciation that you could
have deducted. If you did not deduct the correct amount of depreciation for
property in any year, you may be able to make a correction for that year by
filing Form 1040X, Amended U.S Individual Income Tax Return. If you are not
allowed to make the correction on an amended return, you can change your
accounting method to claim the correct amount of depreciation. See Claiming
the correct amount of depreciation in Publication 527 for more information.
Changing your accounting method to deduct unclaimed depreciation. To
change your accounting method, you must file Form 3115, Application for
Change in Accounting Method, to get the consent of the IRS. In some
instances, that consent is automatic. For more information, see chapter 1
of Publication 946.
Land. You can never depreciate the cost of land because land does not
wear out, become obsolete, or get used up. The costs of clearing, grading,
planting, and landscaping are usually all part of the cost of land and
cannot be depreciated.
More information. See Publication 527 for more information about
depreciating rental property and see Publication 946, How To Depreciate
Property, for more information about depreciation.
Other Rules About Depreciable Property
In addition to the rules about what methods you can use, there are other
rules you should be aware of with respect to depreciable property.
Gain from disposition. If you dispose of depreciable property at a gain,
you may have to report, as ordinary income, all or part of the gain. See
Publication 544, Sales and Other Dispositions of Assets.
Alternative minimum tax. If you use accelerated depreciation, you may
have to file Form 6251. Accelerated depreciation can be determined under
MACRS, ACRS, and any other method that allows you to deduct more
depreciation than you could deduct using a straight line method.
Limits on Rental Losses
Rental real estate activities are generally considered passive activities,
and the amount of loss you can deduct is limited. Generally, you cannot
deduct losses from rental real estate activities unless you have income
from other passive activities. However, you may be able to deduct rental
losses without regard to whether you have income from other passive
activities if you “materially” or “actively” participated in your rental
activity. See Passive Activity Limits, later.
Losses from passive activities are first subject to the at-risk rules.
At-risk rules limit the amount of deductible losses from holding most real
property placed in service after 1986.
Exception. If your rental losses are less than $25,000 and you actively
participated in the rental activity, the passive activity limits probably
do not apply to you. See Losses From Rental Real Estate Activities, later.
Property used as a home. If you used the rental property as a home during
the year, the passive activity rules do not apply to that home. Instead,
you must follow the rules explained earlier under Personal Use of Dwelling
Unit (Including Vacation Home).
At-Risk Rules
The at-risk rules place a limit on the amount you can deduct as losses from
activities often described as tax shelters. Losses from holding real
property (other than mineral property) placed in service before 1987 are
not subject to the at-risk rules.
Generally, any loss from an activity subject to the at-risk rules is
allowed only to the extent of the total amount you have at risk in the
activity at the end of the tax year. You are considered at risk in an
activity to the extent of cash and the adjusted basis of other property you
contributed to the activity and certain amounts borrowed for use in the
activity. See Publication 925 for more information.
Passive Activity Limits
In general, all rental activities (except those meeting the exception for
real estate professionals, later) are passive activities. For this purpose,
a rental activity is an activity from which you receive income mainly for
the use of tangible property, rather than for services.
Limits on passive activity deductions and credits. Deductions for losses
from passive activities are limited. You generally cannot offset income,
other than passive income, with losses from passive activities. Nor can you
offset taxes on income, other than passive income, with credits resulting
from passive activities. Any excess loss or credit is carried forward to
the next tax year.
For a detailed discussion of these rules, see Publication 925.
You may have to complete Form 8582 to figure the amount of any passive
activity loss for the current tax year for all activities and the amount of
the passive activity loss allowed on your tax return.
Exception for real estate professionals. Rental activities in which you
materially participated during the year are not passive activities if, for
that year, you were a real estate professional. For a detailed discussion
of the requirements, see Publication 527. For a detailed discussion of
material participation, see Publication 925.
Losses From Rental Real Estate Activities
If you or your spouse actively participated in a passive rental real estate
activity, you can deduct up to $25,000 of loss from the activity from your
nonpassive income. This special allowance is an exception to the general
rule disallowing losses in excess of income from passive activities.
Similarly, you can offset credits from the activity against the tax on up
to $25,000 of nonpassive income after taking into account any losses
allowed under this exception.
If you are married, filing a separate return, and lived apart from your
spouse for the entire tax year, your special allowance cannot be more than
$12,500. If you lived with your spouse at any time during the year and are
filing a separate return, you cannot use the special allowance to reduce
your nonpassive income or tax on nonpassive income.
The maximum amount of the special allowance is reduced if your modified
adjusted gross income is more than $100,000 ($50,000 if married filing
separately).
Active participation. You actively participated in a rental real estate
activity if you (and your spouse) owned at least 10% of the rental property
and you made management decisions in a significant and bona fide sense.
Management decisions include approving new tenants, deciding on rental
terms, approving expenditures, and similar decisions.
More information. See Publication 925 for more information on the passive
loss limits, including information on the treatment of unused disallowed
passive losses and credits and the treatment of gains and losses realized
on the disposition of a passive activity.
How To Report Rental Income and Expenses
If you rent buildings, rooms, or apartments, and provide only heat and
light, trash collection, etc., you normally report your rental income and
expenses on Form 1040, Schedule E, Part I. However, do not use that
schedule to report a not-for-profit activity. See Not Rented for Profit,
earlier.
If you provide significant services that are primarily for your tenant's
convenience, such as regular cleaning, changing linen, or maid service, you
report your rental income and expenses on Schedule C (Form 1040), Profit or
Loss From Business or Schedule C-EZ, Net Profit From Business (Sole
Proprietorship). Significant services do not include the furnishing of heat
and light, cleaning of public areas, trash collection, etc. For
information, see Publication 334, Tax Guide for Small Business (For
Individuals Who Use Schedule C or C-EZ). You also may have to pay
self-employment tax on your rental income.
Form 1098. If you paid $600 or more of mortgage interest on your rental
property to any one person, you should receive a Form 1098, Mortgage
Interest Statement, or similar statement showing the interest you paid for
the year. If you and at least one other person (other than your spouse if
you file a joint return) were liable for, and paid interest on the
mortgage, and the other person received the Form 1098, report your share of
the interest on Form 1040, Schedule E, line 13. Attach a statement to your
return showing the name and address of the other person. In the left margin
of Schedule E (Form 1040), next to line 13, enter “See attached.”
Schedule E (Form 1040)
Use Form 1040, Schedule E, Part I, to report your rental income and
expenses. List your total income, expenses, and depreciation for each
rental property. Be sure to answer the question on line 2.
If you have more than three rental or royalty properties, complete and
attach as many Schedules E as are needed to list the properties. Complete
lines 1 and 2 for each property. However, fill in the “Totals” column on
only one Schedule E. The figures in the “Totals” column on that Schedule E
should be the combined totals of all Schedules E.
Schedule E, page 2, is used to report income or loss from partnerships, S
corporations, estates, trusts, and real estate mortgage investment
conduits. If you need to use Schedule E, page 2, use page 2 of the same
Schedule E you used to enter the combined totals in Part I.
On Schedule E, page 1, line 20, enter the depreciation you are claiming.
You must complete and attach Form 4562 for rental activities only if you
are claiming:
*
Depreciation on property placed in service during 2005,
*
Depreciation on listed property (such as a car), regardless of when
it was placed in service, or
*
Any car expenses reported on a form other than Schedule C or C-EZ
(Form 1040) or Form 2106 or Form 2106-EZ.
Otherwise, figure your depreciation on your own worksheet. You do not have
to attach these computations to your return.
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