How Is Real Estate Income Treated for Tax Purposes?
Owners of rental real estate are considered real estate investors by the Internal Revenue Service (IRS). When owners receive rent from their tenants for leasing them their homes, they must report that rent as income on their tax returns. Like all businesses, however, owners may "write off" their expenses as deductions for maintaining their rental real estate in rentable condition.
Other People Are Reading
-
Rental Income is Taxable
-
All rental income must be reported in the year that it was physically received. The IRS considers rent that tenants paid early, as money that is immediately available to owners in the year that it was received. It must therefore be claimed as income in that year and not in the year for which it was intended.
Security Deposits
-
Security deposits are not income if they are returned to the tenants upon the completion of the leases. If, however, owners retain any part of the tenants' security deposits for tenant-caused damages to their properties or for unpaid rent, then the owners must claim that part of the retained security deposits as income in the year that they were retained. If those security deposits are then used by the owners for repairs, they will be able to deduct those costs on their income tax returns.
-
Deductions
-
Leasing real estate to tenants is a business and the IRS allows legitimate deductions of expenses incurred for the maintenance of the properties. To maintain rental properties in re-rentable conditions, owners must periodically perform a number of expense-incurring actions. The cost for painting the properties, re-carpeting them, repairing house utility systems such as heating and air conditioning and replacing outdated kitchen appliances, for example, are legitimate expenses that owners can deduct on their income tax returns. The IRS also allows a "cost recovery" through "depreciation" where owners recover the cost of their properties over a number of specific years. The cost of a building, for instance, can be completely depreciated over 27.5 years, after which an owner will have recovered the cost of that property through tax deductions.
Passive Activity
-
The IRS has complex rules about the ability to offset non-real estate income with net losses from passive business activities. As a general rule, it considers the leasing of rental properties a passive activity. Fortunately for rental property owners, there are exceptions in the tax code that permit them to deduct up to $25,000 per year of rental losses against income. To do so, however, they must be actively engaged in the business of leasing their rental units. Specifically they must own at least 10 percent of their real properties plus they must be engaged in major management decisions of those properties, including approving tenants and negotiating rents, for example.
Forms to File
-
Rental income and all deductions are reported on Schedule E, Supplemental Income and Loss. The net income or loss amount is then transferred to page 1 of Form 1040. Any depreciation of the rental property is reported on Form 4562, Depreciation and Amortization. Form 8582, Passive Activity Loss Limitations, is used to summarize income and losses due to passive activities and to compute any deductible losses that may qualify. Finally, Form 8582CR is used to report any passive activity credit limitations that may affect the owner's bottom line.
-
References
- Photo Credit tax forms image by Chad McDermott from Fotolia.com
