The key to mastering the Schedule E is to organize your income and expenses using a spreadsheet or personal finance software program. In my experience, clients who
keep detailed summaries of their rental property expenses are the ones who benefit most at tax time from the generous tax rules regarding rental income.
Here's some tips. First, just like filing out a Schedule D for stock investments, landlords need to keep excellent records regarding cost basis, income, and expenses. And the number one best way to keep track of all this? Set up a spreadsheet (either on paper or on the computer). Your tax accountant may even have a spreadsheet template you can use.
As a landlord, here are the things you need to keep track of:
- Purchase price of the house, condo, or apartment building you are renting out,
- Accumulated depreciation, and current annual depreciation on your property,
- Rental income,
- Security deposits you received.
In addition, you will need to keep track of various expenses associated with your rental property, including:
- Commissions or property management fees,
- Advertising costs,
- Cleaning, maintenance, and repair costs,
- Homeowners insurance and HOA dues,
- Real estate taxes and mortgage interest expenses,
- Security deposits reimbursed to the tenant.
- and various other expenses, such as utilities, landscaping, garbage, and so forth.
As you can see, it will be particularly helpful if you track these various expenses using personal finance software or a computer spreadsheet, so that monthly and year-end reports can be quickly printed out.
Passive Activity Losses
Renting out real estate property is generally considered a passive activity, even if you devote a substantial amount of time to selecting the right tenants, repairing the rental unit, and inspecting the property for routine maintenance. What this means is that the IRS limits your losses from your rental business to a maximum of $25,000 per year. The rules and criteria for Passive Activity Losses are found in IRS Instructions for Schedule E. Note: this is $25,000 in total losses from all your rental properties.
Tax Planning for Landlords
Landlords normally make a small profit on their rental income. This is the case because rental income is usually sufficient to pay the mortgage, and plus a little extra for taxes, insurance, and repairs. However, landlords get to depreciate the purchase price of the rental property, which is usually sufficient to turn a small economic profit into a small tax loss. That means expenses exceed income after depreciation is taken into consideration. The IRS provides a tax break for homeowners who rent out their property instead of using the property as a personal residence.
Every so often, however, landlords face major expenses, such as replacing a roof, or gutting an apartment after a long-term tenant vacates. In these circumstances, it is possible that the landlord has a loss greater than $25,000. But the Passive Activity Loss rules will limit the loss. The actual amount of losses that can be deducted is a maximum of $25,000, but it could be less depending on the landlord's level of income. Any losses not currently deductible will be carried over to the following year, when hopefully the landlord will have more of a profit and will be able to absorb the excess tax losses.
Selling Rental Properties
Selling a house, apartment building, or other rental property is different than selling your main home. Different rules apply for calculating your taxes. Just like calculating capital gains, the formula for calculating the gain or loss of rental property involves subtracting your cost basis from your selling price.
The formula for calculating your cost basis on rental property is as follows:
- Purchase price
- + Purchase costs (title & escrow fees, real estate agent commissions, etc.)
- + Improvements (replacing the roof, new furnace, etc.)
- + Selling costs (title & escrow fees, real estate agent commissions, etc.)
- - Accumulated depreciation (as reported on your tax forms)
- = Cost Basis
And then calculating your profit or loss would be:
- Selling price
- - Cost Basis
- = Gain or Loss
If the resulting number is positive, you made a profit when you sold your rental property. If the resulting number is negative, you incurred a loss when you sold your rental property. Profits on rental property can be taxed partly as ordinary gain and partly as capital gain. This is due to rules for rental property contained in the Internal Revenue Code Section 1231, which is discussed in IRS Publication 544. Gains are reported on Form 4797.
Real Property and Limited Liability
Many clients have asked me about forming corporations to own their rental properties. A real estate attorney is really the person to ask. But here's the tax perspective. If you form a general partnership, you may be exposing yourself to unlimited liabilities that arise from lawsuits and other legal risks. If you form a regular C-Corporation, you have limited liability protection, but you lose the ability to pass-through your income and losses to your personal 1040. If you form an S-Corporation or Limited Liability Company, you have limited liability protection and you pass through all profits and losses to your 1040. From a tax perspective, forming an LLC or S-corp to own your rental property sounds appealing. Nonetheless, setting up a formal business entity, transferring title, and getting the tenants to sign new leases with the S-Corp or LLC as the owner may prove a time-consuming project. Landlords should discuss other legal aspects of forming an LLC or S-corp or other business structure around their rental properties with their attorney. Besides limited liability, landlords should ask about how they can transfer ownership of their company to their children and other heirs, how they can achieve legal protection through other means such as insurance, and just what legal protections they need.
It would have been helpful to me ( a beginner) if you recommended a software program to start with.
More reading materials of a how to nature.
Thank you,
Kay Martin
Hello –
How many years can you carry the loss forward? 10 Years? 15 Years.
thank you,
Passive losses are carried forward indefinitely and can offset future passive income or become unlocked in full when you sell a property. And this can really help to mitigate the tax hit from depreciation recapture. As for software recommendations, the best thing to do (in my mind anyways) is to keep an excellent record of your rental income and expenses using a spreadsheet or personal finance program. That way you’ll have a paper trail for whichever tax software you pick.
We rent my former MIL’s mobile home. The taxes last year were done by a preparation firm and now I can’t figure out how they got the depreciation figure. What form to I use to figure the depreciation?
Les: Your accountant should have provided you with an asset worksheet. This piece of paper would show the original cost for the land, improvements, when the property was first placed in service as a rental, last year’s calculated depreciation, and the accumulated depreciation for all years as a rental. You’ll need these data inputs to correctly calculate your depreciation for this year. If you don’t have that worksheet, call the previous accountant and ask them for a copy.
Great article! 1 question, how do you figure out depreciation on a property like a single family home that I have rented out…
Frank, good question. Basically, you’ll need to dig up an appraisal report (or a recent valuation from your county’s tax assessor) to determine the split between land and improvements. Land is a nondepreciating asset, so remove that portion from the cost of the house. The rest of the cost is then depreciated over 27.5 years. Your software can help you do this. Additional details can be found in Publication 946, How To Depreciate Property.
Have a rental we had to do extensive repairs on after the last tenent vacated in January 2008. Have been unable to rent since & decided to move back into as our main home. Moved into rental before the end of 2008. Are we allowed to show our expenses & income losses up to the time we resumed living in the rental?
I believe that it is false to say that “the remainder will be carried forward”, when speaking of the $25,000 loss limit.
I think the correct language would be “whatever exceeds $25,000 OR whatever is unused in the current tax year, can be carried forward”
If your AGI is such that you cannot even use up the $25,000 loss or whatever loss you have, I believe you can carry forward whatever loss you have that exceeds your income, even if less than $25,000.
Will Johnson, that’s a much better way to phrase it. I have updated my article accordingly.
Your comments were very helpfull. I was in a hurry to create an LLC becasue I was buying a rental property, now that I know I can deduct all those items, I will wait to create the company.
I inherited a mobile home on it’s own property that is in another state from where I live, I have done some work on it recently to make it liveable. I have someone that would like to rent it starting in September. I have to be careful that it does not cause a change in my husbands disability social security or VA financial requirements for his health care. It is our only means of support since I have to be his full time care taker. Medicare with the VA pay for my husbands medical needs. I have no other tax deductions. I don’t know if this is worth doing because of the financial and medical cost risk involved. I don’t know how to figure this out. If I form a LLC and funnel the earnings into that separate bank account, would it protect our current income? Would it be worth it since I am not making payments on the house anyway? Since you are saying that the income realized is usually small, I am in real fear of having my husbands medical expenses not being covered or losing our social security or having to pay taxes at the end of the year when we just don’t have enough extra to cover them. I appreciate your advice.
I own 6 single family dwelling should I put each home in a LLC?
Pat, that’s a good question to ask your attorney.
In what way does an S Corporation potentially expose one to unlimited liability?
That runs counter to the advice I receive.
Thanks for pointing that out, Jeff. I have revised my article accordingly.
I am confused about how to tell if I am taking a loss or making a profit. If my mortgage is $1800, property taxes are $800, and homeowners insurance is $100.00 per month and the rent I can get for the house is approximately $2200 per month, am I making a $400 profit per month or taking a $500 loss each month?
Please advise, as I am about to lose my house.
You raise a good question, Louisa. You’ll calculate your profit or loss a little differently for tax purposes compared to just measuring money coming in and money going out. The basic equation for profit is Rental Income minus Rental Expenses. And there’s a couple of twists to each part of that equation.
First, rental income only includes rent payments; it generally does not include any security deposits (since those are usually refunded back to the tenant); any deposits you don’t refund back to the tenant are included in income at the time the deposit is forfeited.
Second, you’re allowed a deduction for mortgage interest paid during the year and a separate depreciation expense where you take the purchase price of the property’s building and improvements (but not land) and spread it out over 27.5 years. These two expense items usually won’t add up to be the same as the monthly mortgage payment.
Based on the information you provided, I would say that the rental property is “cash flow negative” meaning that your actual cash outflow is 500 more than your actual cash inflow. Your tax numbers will likely be slightly different than these figures once you take into account depreciation, repairs, utilities and so forth. When advising landlords I look at both measures — the tax calculations for profits and the actual cash flow — in order to help the landlord analyze her financial situation.
Hope this helps.
I recently came into inheritance money and paid my house off in February. I have also started renting the house at that time. Should I open an LLC to get any write-offs for this property? Also would it be better to have an LLC for rental income and expenses?
This is a great website with lots of useful information! A few questions… would private mortgage insurance be considered an expense on Schedule E? Is it subject to the same income limitations as a primary residence? If it is an expense, would it be listed on Line 9? Thanks for the help.
Thank you so much for this website! Hope you can help in an unusual situation. Escrow is closing on a sale of property we do not own, but made improvements on starting in 2010 (we were landlords, collected the rent, improved the property). (Although our partner holds title, all agreed upon). We have the option of getting the 1099 (through a quit claim) on either 100% or 50% of sale proceeds OR just having the check issued to our partner and working it out ourselves. The issue is whether or not WE can claim our expenses from 2010, 2011 and 2012 as far as this property without actually holding title. Is it better to claim this as a business (Schedule E) venture (amending 2010) and NOT get the 1099 after it closes? Do you think there will be a tax issue or that our expenses will be disallowed because we did not hold title on the property? Thanks in advance for any suggestions you might have.
Claire, a very interesting situation. Income and expenses for rental property is claimed by the owner of the property. Since you are not the owner, I see no reason why you should be reporting either income from, expenses relating to or the sale of property that you don’t own. If you incurred expenses related to this property, you should seek reimbursement from the property’s owner.
Very nice article.
Can I deduct the closing cost when buying a rental property? Is the interest paid at closing included in the year end I-1098?
I purchased a home in 2004 that I lived in for four years. In Jan. 2009 I moved out and a renter took over. My expenses on the house exceed my income each year by about $7,000. My tax accountant says I can not apply this loss against my other income so what do I do with it? Exactly what are “passive losses” and how do they affect me. I expect to sell the house this coming year for a lot less than I paid for it so there will be no capital gains.
Can you tell me which line on Schedule E is the line I should put the passive loss carryover from last year? Last year was my first year to be a landlord and my loss was more than $25,000 so I have a carryover. Thank you!
Susan, you use Form 8582 for reporting passive loss carryovers and calculating how much is deductible this year.