Top Frequently Asked Questions for Sale or Trade of Business, Depreciation, Rentals

What forms do we file to report a loss on the sale of a rental property?

Answer:

Rental property is income-producing property and, if you are in the trade or business of renting real property, report the loss on the sale of rental property on Form 4797 , Sales of Business Property. Normally, you transfer the loss as an ordinary loss to line 14 of Form 1040, U.S. Individual Income Tax Return. If your rental activity does not rise to the level of a trade or business, but instead is held for investment or for use in a not-for-profit activity, the loss is a capital loss. Report the loss on Form 8949 in Part I (if the transaction is short term) or Part II (if the transaction is long term). If your capital losses are more than your capital gains, you can deduct the difference as a capital loss deduction even if you don’t have ordinary income to offset it. The yearly limit on the amount of the capital loss you can deduct is $3,000 ($1,500 if you are married and file a separate return). Normally, you transfer the capital loss to line 13 of Form 1040. See the Instructions for Form 8949, the Instructions for Form 4797, and the Instructions for Schedule D (Form 1040).

I purchased a rental property last year. What closing costs can I deduct?

Answer:

Generally, deductible closing costs are those for interest, certain mortgage points, and deductible real estate taxes.

Many other settlement fees and closing costs for buying the property become additions to your basis in the property and part of your depreciation deduction, including:

  • Abstract fees
  • Charges for installing utility services
  • Legal fees
  • Recording fees
  • Surveys
  • Transfer taxes
  • Title insurance
  • Any amounts the seller owes that you agree to pay (such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions).

Subcategory:

I am renting a house to my son and daughter-in-law. Can I claim rental expenses?

Answer:

In general, if you receive income from the rental of a dwelling unit, such as a house, apartment, or duplex, you can deduct certain expenses.

Besides knowing which expenses may be deductible, it's important to understand potential limitations on the amounts of rental expenses that you can deduct in a tax year.

There are several types of limitations that may apply.

Not-for-profit activities:

  • If you don't rent your property to make a profit, you can deduct your rental expenses only up to the amount of your rental income.
  • You can't carry forward rental expenses in excess of rental income to the next year.
  • Refer to Publication 527, Residential Rental Property, and Publication 535, Business Expenses.

Rental of a dwelling unit (for profit):

  • The tax treatment of rental income and expenses for a dwelling unit that you also use for personal purposes depends on how many days you used the unit for personal purposes.
  • Renting to relatives may be considered personal use even if they're paying you rent, unless the family member uses the dwelling unit as his or her main home and pays rent equivalent to the fair rental value.
  • Refer to Publication 527, Residential Rental Property.

Passive activity losses:

  • In general, you can deduct passive activity losses to the extent of passive activity income (a limit on loss deductions).
  • You carry any excess loss forward to the following year or years until used, or you carry any excess loss forward until the year you dispose of your entire interest in the activity in a fully taxable transaction.
  • There are several exceptions that may apply to the passive activity limitations. Refer to Publication 527, Residential Rental Property, and Publication 925, Passive Activity and At-Risk Rules.

At-risk rules:

The at-risk rules limit your losses from most activities to your amount at risk in the activity.

  • You treat any loss disallowed because of the at-risk limits as a deduction from the same activity in the next tax year.
  • If your losses from an at-risk activity are allowed in a previous taxable year and your amount at risk drops below zero at the close of any later taxable year, then you must include a recapture amount in your gross income for such later taxable year.
On what form do I deduct the standard mileage rate for my business travel, and do I also need to figure depreciation of the vehicle?

Answer:

Many taxpayers find using the standard mileage rate an easier way to expense their vehicle. You can't depreciate the vehicle if you use the standard mileage rate. Instead of the standard mileage rate, you can use the actual expense method. If you use this method, you need to figure depreciation for the vehicle.

You can claim business use of an automobile on:

I have a home office. Can I deduct expenses like mortgage, utilities, etc., but not deduct depreciation so that when I sell this house the basis won't be affected?

Answer:

Regular Method - No, all allowed or allowable depreciation must be considered at the time of sale. You can generally figure depreciation on the business use portion of your home up to the gross income limitation, over a 39 year recovery period and using the mid-month convention. As long as you determine actual expenses and the correct amount of allowed or allowable depreciation, the depreciation reduces the basis of your home accordingly, whether or not you actually claim it on your tax return.  

Simplified Option - There's a simpler option, as announced in Revenue Procedure 2013-13, where qualifying taxpayers may use a prescribed rate ($5 per square foot limited to 300 square feet) to compute their business use of home deduction. This option used in lieu of determining actual expenses has the advantage of reducing taxpayers' recordkeeping burden. Under this option, depreciation is treated as zero and won't reduce the basis of your home. For more information, visit Home Office Deduction, Simplified Option for Home Office Deduction, and FAQs – Simplified Method for Home Office Deduction. In addition, under this optional method, taxpayers can still deduct business expenses unrelated to qualified business use of the home for that taxable year, such as advertising, wages, and supplies.

We have incurred costs for substantial work on our residential rental property. We replaced the roof with all new materials, replaced all the gutters, replaced all the windows and doors, replaced the furnace, and painted the property’s exteriors. What are the IRS rules concerning depreciation?

Answer:

Replacements of the entire roof and all the gutters, and all windows and doors of your residential rental property:

  • Are generally restorations to your building property because they're replacements of major components or substantial structural parts of the building structure. As a result, these replacements are capital improvements to the residential rental property.
  • Are in the same class of property as the residential rental property to which they're attached.
  • Are generally depreciated over a recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention as residential rental property.

Repainting the exterior of your residential rental property:

  • By itself, the cost of painting the exterior of a building is generally a currently deductible repair expense because merely painting isn't an improvement under the capitalization rules.
  • However, if the painting directly benefits or is incurred as part of a larger project that's a capital improvement to the building structure, then the cost of the painting is considered part of the capital improvement and is subject to capitalization.
  • In this case, the painting is incurred as part of the overall restoration of the building structure. Therefore, the repainting costs are part of the capital improvements and should be capitalized and depreciated as the same class of property that was restored, as discussed above.

Replacement of the furnace in your residential rental property:

  • Is generally a restoration to your building property because it's for the replacement of a major component or substantial structural part of the building's HVAC system. Therefore, the furnace replacement is a capital improvement to your residential rental property.
  • As with the restoration costs discussed above, these costs are in the same class of property as the residential rental property to which the furnace is attached.
  • Is generally depreciated over a recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention as residential rental property.

Note: A taxpayer whose average annual gross receipts is less than or equal to $10,000,000 may elect to not capitalize amounts paid for repairs, maintenance, or improvements of certain eligible building property if the total amounts paid during the taxable year for such activities don't exceed certain dollar limitations. For more information, see Safe Harbor Election for Small Taxpayers in Tangible Property Regulations - Frequently Asked Questions.

We sold a rental property last year and used the like-kind exchange rules under section 1031 of the Internal Revenue Code to purchase a replacement property and defer the gain of the rental property sold. How do I report this transaction on my tax return?

Answer:

Report the exchange of like-kind property on Form 8824, Like-Kind Exchanges. The Instructions for Form 8824 explain how to report the details of the exchange. Even if you recognize no gain or loss, you must report the exchange.

If you received money or other property (not like-kind) as part of the exchange, you must recognize gain to the extent of the amount of money or the value of other property you received, but you don't recognize a loss. For this purpose, consideration received by a taxpayer in the form of an assumption of a liability by the other party to the exchange or the transfer by the taxpayer of property subject to a liability is treated as money or other property. However, a taxpayer may offset a liability assumed with consideration given by the taxpayer assuming a liability or receiving a property subject to a liability in the exchange. You must report recognized gain on Form 4797, Sales of Business Property, and Schedule D (Form 1040), Capital Gains and Losses. Refer to the detailed section on qualifying like-kind exchanges in Chapter 1, Gain or Loss, in Publication 544, Sales and Other Dispositions of Assets.

I have a home office. Can I deduct expenses like mortgage, utilities, etc., but not deduct depreciation so that when I sell this house the basis won't be affected?

Answer:

Regular Method - No, all allowed or allowable depreciation must be considered at the time of sale. You can generally figure depreciation on the business use portion of your home up to the gross income limitation, over a 39 year recovery period and using the mid-month convention. As long as you determine actual expenses and the correct amount of allowed or allowable depreciation, the depreciation reduces the basis of your home accordingly, whether or not you actually claim it on your tax return.  

Simplified Option - There's a simpler option, as announced in Revenue Procedure 2013-13, where qualifying taxpayers may use a prescribed rate ($5 per square foot limited to 300 square feet) to compute their business use of home deduction. This option used in lieu of determining actual expenses has the advantage of reducing taxpayers' recordkeeping burden. Under this option, depreciation is treated as zero and won't reduce the basis of your home. For more information, visit Home Office Deduction, Simplified Option for Home Office Deduction, and FAQs – Simplified Method for Home Office Deduction. In addition, under this optional method, taxpayers can still deduct business expenses unrelated to qualified business use of the home for that taxable year, such as advertising, wages, and supplies.

I've heard that I can sell my rental property and use the proceeds to purchase rental property of equal or greater value and the transaction is viewed just like an exchange in that the tax is deferred until the new property is sold. Is this true?

Answer:

Yes. What you've heard about is a transaction commonly known as a like-kind exchange. A like-kind exchange, when properly executed, can postpone the recognition of gain (and resulting current tax) essentially by shifting the basis of property sold to like-kind replacement property. You do this by acquiring a like-kind property, which may be of lesser or greater value.

The basis of the property that you acquire in a like-kind exchange is generally the same as the basis of the property that you transferred. However, if you transfer money or other property (not like-kind) in addition to like-kind property, your basis in the property acquired is the basis of the property given up, increased by the amount of money or other property transferred.  

To successfully defer gain in a like-kind exchange, you must comply with certain requirements under section 1031 of the Internal Revenue Code and the regulations thereunder. For example, when you sell your rental property, you can't take actual or constructive receipt of the sale proceeds. You can avoid actual or constructive receipt of the proceeds if you comply with one of the safe harbors, such as using a qualified intermediary or a qualified trust to hold and use the sale proceeds to acquire the replacement property, as set forth in the Income Tax Regulations or certain other publications of the Internal Revenue Service.

Frequently Asked Question Subcategories for Sale or Trade of Business, Depreciation, Rentals