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Figuring the net income or loss for a residential rental activity may involve more than just listing the income and deductions on Schedule E (Form 1040). There are activities that do not qualify to use Schedule E, such as when the activity is not engaged in to make a profit or when you provide substantial services in conjunction with the property.
There are also the limitations that may need to be applied if you have a net loss on Schedule E. There are two: (1) the limitation based on the amount of investment you have at risk in your rental activity, and (2) the special limits imposed on passive activities.
The basic form for reporting residential rental income and expenses is Schedule E (Form 1040). However, do not use that schedule to report a not-for-profit activity. See Not Rented for Profit , in chapter 4. There are also other rental situations in which forms other than Schedule E would be used.
If you rent buildings, rooms, or apartments, and provide basic services such as heat and light, trash collection, etc., you normally report your rental income and expenses on Schedule E, Part I.
List your total income, expenses, and depreciation for each rental property. Be sure to enter the number of fair rental and personal use days 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 lines 23a through 26 on only one Schedule E.
On Schedule E, page 1, line 18, enter the depreciation you are claiming for each property. To find out if you need to attach Form 4562, see Form 4562 , later.
If you have a loss from your rental real estate activity, you also may need to complete one or both of the following forms.
Page 2 of Schedule E is used to report income or loss from partnerships, S corporations, estates, trusts, and real estate mortgage investment conduits. If you need to use page 2 of Schedule E, be sure to use page 2 of the same Schedule E you used to enter your rental activity on page 1. Also, include the amount from line 26 (Part I) in the “Total income or (loss)” on line 41 (Part V).
Depreciation, including the special depreciation allowance, on property placed in service during 2016;
Depreciation on listed property (such as a car), regardless of when it was placed in service; or
Any other car expenses, including the standard mileage rate or lease expenses.
Generally, Schedule C is used when you provide substantial services in conjunction with the property or the rental is part of a trade or business as a real estate dealer.
If you and your spouse each materially participate (see Material participation under Passive Activity Limits, later) as the only members of a jointly owned and operated real estate business, and you file a joint return for the tax year, you can make a joint election to be treated as a qualified joint venture instead of a partnership. This election, in most cases, will not increase the total tax owed on the joint return, but it does give each of you credit for social security earnings on which retirement benefits are based and for Medicare coverage if your rental income is subject to self-employment tax.
If you make this election, you must report rental real estate income on Schedule E (or Schedule C if you provide substantial services). You will not be required to file Form 1065 for any year the election is in effect. Rental real estate income generally is not included in net earnings from self-employment subject to self-employment tax and generally is subject to the passive activity limits.
If you and your spouse filed a Form 1065 for the year prior to the election, the partnership terminates at the end of the tax year immediately preceding the year the election takes effect.
For more information on qualified joint ventures, go to IRS.gov and enter “qualified joint venture” in the search box.
If you have a loss from your rental real estate activity, two sets of rules may limit the amount of loss you can deduct. You must consider these rules in the order shown below. Both are discussed in this section.
At-risk rules. These rules are applied first if there is investment in your rental real estate activity for which you are not at risk. This applies only if the real property was placed in service after 1986.
Passive activity limits. Generally, rental real estate activities are considered passive activities and losses are not deductible unless you have income from other passive activities to offset them. However, there are exceptions.
You may be subject to the at-risk rules if you have:
A loss from an activity carried on as a trade or business or for the production of income, and
Amounts invested in the activity for which you are not fully at risk.
Losses from holding real property (other than mineral property) placed in service before 1987 are not subject to the at-risk rules.
In most cases, 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. Any loss that is disallowed because of the at-risk limits is treated as a deduction from the same activity in the next tax year. See Pub. 925 for a discussion of the at-risk rules.
In most cases, all rental real estate activities (except those of certain real estate professionals, discussed 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. For a discussion of activities that are not considered rental activities, see Rental Activities in Pub. 925.
Deductions or 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. Exceptions to the rules for figuring passive activity limits for personal use of a dwelling unit and for rental real estate with active participation are discussed later.
For a detailed discussion of these rules, see Pub. 925.
More than half of the personal services you perform in all trades or businesses during the tax year are performed in real property trades or businesses in which you materially participate.
You perform more than 750 hours of services during the tax year in real property trades or businesses in which you materially participate.
Develops or redevelops it.
Constructs or reconstructs it.
Rents or leases it.
Operates or manages it.
If you used the rental property as a home during the year, any income, deductions, gain, or loss allocable to such use shall not be taken into account for purposes of the passive activity loss limitation. Instead, follow the rules explained in chapter 5, Personal Use of Dwelling Unit (Including Vacation Home).
If you or your spouse actively participated in a passive rental real estate activity, you may be able to 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 may be able to 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.
Jane is single and has $40,000 in wages, $2,000 of passive income from a limited partnership, and $3,500 of passive loss from a rental real estate activity in which she actively participated. $2,000 of Jane's $3,500 loss offsets her passive income. The remaining $1,500 loss can be deducted from her $40,000 wages.
Mike is single and had the following income and losses during the tax year:
The rental loss was from the rental of a house Mike owned. Mike had advertised and rented the house to the current tenant himself. He also collected the rents, which usually came by mail. All repairs were either made or contracted out by Mike.
Although the rental loss is from a passive activity, because Mike actively participated in the rental property management he can use the entire $4,000 loss to offset his other income.
$25,000 for single individuals and married individuals filing a joint return for the tax year,
$12,500 for married individuals who file separate returns for the tax year and lived apart from their spouses at all times during the tax year, and
$25,000 for a qualifying estate reduced by the special allowance for which the surviving spouse qualified.
The taxable amount of social security or equivalent tier 1 railroad retirement benefits,
The deductible contributions to traditional individual retirement accounts (IRAs) and section 501(c)(18) pension plans,
The exclusion from income of interest from Series EE and I U.S. savings bonds used to pay higher educational expenses,
The exclusion of amounts received under an employer's adoption assistance program,
Any passive activity income or loss included on Form 8582,
Any rental real estate loss allowed to real estate professionals,
Any overall loss from a publicly traded partnership (see Publicly Traded Partnerships (PTPs) in the Instructions for Form 8582),
The deduction allowed for one-half of self-employment tax,
The deduction allowed for interest paid on student loans,
The deduction for qualified tuition and related fees, and
The domestic production activities deduction (see the Instructions for Form 8903).
Your only passive activities were rental real estate activities in which you actively participated.
Your overall net loss from these activities is $25,000 or less ($12,500 or less if married filing separately and you lived apart from your spouse all year).
If married filing separately, you lived apart from your spouse all year.
You have no prior year unallowed losses from these (or any other passive) activities.
You have no current or prior year unallowed credits from passive activities.
Your MAGI is $100,000 or less ($50,000 or less if married filing separately and you lived apart from your spouse all year).
You do not hold any interest in a rental real estate activity as a limited partner or as a beneficiary of an estate or a trust.
As a result of a casualty or theft, you may have a loss related to your rental property. You may be able to deduct the loss on your income tax return.
In February 2011, Marie bought a rental house for $135,000 (house $120,000 and land $15,000) and immediately began renting it out. In 2016, she rented it all 12 months for a monthly rental fee of $1,125. In addition to her rental income of $13,500 (12 x $1,125), Marie had the following expenses.
|Fire insurance (1-year policy)||250|
|Real estate taxes imposed and paid||500|
Marie depreciates the residential rental property under MACRS GDS. This means using the straight line method over a recovery period of 27.5 years.
She uses Table 2-2d to find her depreciation percentage. Because she placed the property in service in February 2011, she continues to use that row of Table 2-2d. For year 6, the rate is 3.636%.
Marie figures her net rental income or loss for the house as follows:
|Total rental income received
($1,125 × 12)
|Real estate taxes||500|
|Minus: Depreciation ($120,000 x 3.636%)||4,363|
|Net rental (loss) for house||($213)|
Marie had a net loss for the year. Because she actively participated in her passive rental real estate activity and her loss was less than $25,000, she can deduct the loss on her return. Marie also meets all of the requirements for not having to file Form 8582. She uses Schedule E, Part I, to report her rental income and expenses. She enters her income, expenses, and depreciation for the house in the column for Property A and enters her loss on line 22. Form 4562 is not required.
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