The internet has made connecting renters and property owners much easier. Aside from finding renters, what other circumstances are at play when renting a home or vacation home?
Rental Income
Most individual taxpayers are “cash basis”. This means income is reported in the year cash is received.
Common types of income include:
- Advance rent – Any amount received before the period it covers.
- Canceling a lease – Any amount received from tenant to cancel a lease.
- Landlord’s expenses paid by tenant – Any amount paid or reimbursed by tenant for expenses of the landlord (real estate tax, repairs, etc.). These expenses may be deductible by the landlord.
- Security deposits – Any amount kept as a result of tenant not complying with the lease. If any part of the security deposit is used to pay final rent, it is advance rent (see above).
Income does not include security deposits that you plan to return.
Rental Expenses
As a “cash basis” taxpayer, qualified rental expenses are deductible in the year paid.
Common types of expenses include:
- Advertising
- Maintenance
- Insurance
- Mortgage Interest
- Management Fees
- Repairs
- Taxes
- Utilities
- Depreciation
For a detailed description of deductible expenses, refer to the IRS Publication 527 or the instructions to Federal tax form Schedule E for the applicable tax year. For a walk-through explanation of Schedule E, watch WFA’s YouTube video.
Rental Property Also Used as Your Home
If you rent a property for less than 15 days that also serves as your dwelling unit, do not include the rent as income. Similarly, any direct expenses relating to the rental activity or indirect expenses relating to the dwelling unit are not considered deductible rental expenses.
If you rent a property for more than 15 days that also serves as either your primary dwelling unit or a part-time dwelling unit (ex. vacation home), all rental income must be reported on Schedule E and only deductible rental expenses shall be reported on Schedule E. To determine deductible rental expenses, total expenses must be divided between rental use and personal use based on the number of days used for either activity. Personal use expenses not deductible on Schedule E may be deductible on Schedule A if otherwise allowable (real estate taxes and mortgage interest).
Passive Activity Limits vs. Active Participation
In general (with the exception of real estate professionals), rental real estate activities are passive activities. Tax losses from passive activities are deductible only up to the amount of passive activity gains. Any excess tax losses are suspended and carried forward to future years to offset future passive activity gains. However, there is an exception to this treatment if you “actively participate” in the rental activity.
You are considered an active participant if:
- You owned at least 10% of the property, and
- Made management decisions (i.e. approved tenants, decided rental terms, approve expenses).
Tax losses (up to $25,000) from active participation in a rental activity can be claimed in the current tax year to offset other income like wages, pensions, etc.