Tips About Rental Income and Expenses
Morphing what was once a vacation get-way into an income-generating property is one way a lot of families and individuals are coping with the recession. The IRS recently reported, for example, a 10 % increase in the number of taxpayers reporting some of kind of rental on their federal income returns since 2007. This reminds us that finding tenants, executing rental agreements and dealing with home maintenance aren’t the only items on the laundry list of new or would-be landlords. Dealing with Uncle Sam is atop that list.
Enrolled agents, CPA and any registered tax agent working with clients who rent, and earn money from the property, should understand the following seven facts about rental income and expenses.
(1) When to report income. Taxpayers who rent generally must report rental income on their tax returns in the year that they actually receive it.
(2) Advance rent. Advance rent is any amount received before the period that it covers. Individuals should include advance rent in their rental income in the year they receive it, regardless of the period covered.
(3) Security deposits. Taxpayers should not include a security deposit in income when it is receive if they plan to return it to the tenant at the end of the lease. But if the landlord intends to keep part or all of the security deposit during any year because the tenant does not live up to the terms of the lease, the amount kept should be included in the income for that year.
(4) Property or services in lieu of rent. If a taxpayer receives property or services, instead of money, as rent, the fair market value of the property or services must be included in the 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.
(5) Expenses paid by tenant. If a tenant pays any of the expenses, the payments are considered rental income and should be included in the landlord’s income. However, these expenses can be deducted if they are deductible rental expenses. See below or “Rental Expenses in Publication 527,” for more information.
(6) Rental expenses. Generally, the expenses of renting a property, such as maintenance, insurance, taxes, and interest, can be deducted from your rental income. See below
(7) Personal use of vacation home. If a taxpayer has any personal use of a vacation home or other dwelling unit that you rent out, then the expenses must be divided between rental use and personal use. If the expenses for rental use are more than rental income, the taxpayer may not be able to deduct all of the rental expenses. See below
The decision to turn a home into a rental has a number of tax advantages beyond the perks of deducting mortgage interest and property tax. Any enrolled agent or tax professional knows this. The tricky part is qualifying for those tax benefits.
Entire tax CPE courses are devoted to this subject, which tell us that capitalizing on the perks of being a landlord hinge on two factors: income and most important, how often the rightful property owner uses the home.
Consider the following scenarios:
Barely Ever Rented
HOMEOWNER: Uses beach house primarily for own purposes and only rents it out for a week during Spring Break.
TAX IMPLICATIONS: The most straightforward scenario. If a vacation house is rented out for less than 15 days each year, the rental income does not have to be reported. While the house still qualifies for the mortgage interest, property tax deductions and write offs for casualty and theft losses, property owner in this category are not able to deduct any other operating and maintenance expenses connected to the house.
Often Rented, but Rarely Used by the Owner
HOMEOWNER: Visits a ski condo for just a single prime week in December, but rents it out for the remainder of the peak season (Jan-March)
TAX IMPLICATIONS: Because the property is rented out for 15 days or more, that rental income must be reported. But the homeowner is now able to deduct all of the expenses associate with marketing and maintaining the condo, including all utilities, cable television, property management fees, property insurance and home improvements.
The IRS has set the usage criteria at 14 days, or 10 percent of the number of days a property was leased out at fair market value, as the maximum amount of time at which a property owner can record a loss. Say that $35,000 in annual rental income meant $40,000 in maintenance, improvements and various other expenses, a homeowner can take a $5,000 loss on the property.
However, homeowners making more than $150,000 aren’t so lucky. Incomes above this amount disqualify homeowners from these write-offs. Instead the loss goes into what the IRS has described as a “suspended loss.” However, once the rental property starts turning a profit, homeowners may take advantage of the losses incurred years in the form of a deferred tax benefit.
Sale
If a homeowner makes a profit on the property with its sale, but has been depreciating the house, that homeowner should expect a 25 % tax bill, regardless of whether they have been taking a loss on the property or not.
Often Rented and Used by the Owner
HOMEOWNER: Rents out a Maine cabin for three months of the year but uses it the entire month of March.
TAX IMPLICATIONS: The property owner must report the rental income and may deduct the expenses associated with operating the house as a rental. However, because it was used for more than 14 days, the IRS will not permit does the property owner to write off more than the value of the annual rental income. In other words, that homeowner cannot record a loss on the property.
But not all of the days a property owner spends at the house have to count toward personal use. For example, time spent fixing up a property. Not only are those days not considered personal use, but all travel expenses can qualify as deductible expenses. “
IRS To Start to Look at Rental Income More Closely
The Treasury Inspector General for Tax Administration, or TIGTA, the federal office that keeps monitors the IR, recently reported that over 50 % of taxpayers with rental real estate activity in 2001 misreported their income and losses to the tune of nearly $13 billion. In response, the IRS is considering implementing procedures around how to better analyze and crack-down on returns that under-report rental income
The bottom line for taxpayers with rental property is to make sure they understand and follow the tax rules. One way, of course, is to consult a tax professional whose tax continuing education will help them sort through these issues.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.