Rental Income Taxes
Income you receive for letting someone use or occupy your property is rental income.
Rental income includes:
- Advance rental payments
- Current payments
- Late payments
- Expenses paid by tenants
Payments you receive for lease cancellation and forfeited security deposits are rental income. They’re income for the year:
- The lease is canceled
- The security deposit is forfeited
Rental income is considered passive income for the passive-loss rules limitation. This is true except for qualified real estate professionals. If your rental income is more than your expenses, you’ll report the income. However, if your rental income is less than your expenses, you must consult special rules. These rules tell you if you can take the loss against other income.
At-risk refers to what you’ve invested in a particular activity. For rental activities, you’re usually at risk for the:
- Adjusted basis of real properties
- Certain amounts you’ve borrowed
- Cash you’ve invested in the activity
Under the at-risk rules, your losses are limited to amounts you have at risk.
Rental real estate often creates a loss since it has large depreciation deductions and cash expenses, like:
- Mortgage interest
You can usually deduct passive-activity losses. You can calculate your losses this way:
passive activity deduction – passive activity gross income = passive activity loss
The passive-loss rules determine if you can take the loss against other income. If you can’t, you have to carry over the loss into another year, offsetting that year’s passive income.
Usually, you can’t deduct passive losses from nonpassive income, like wages. You might have several sources of passive income, like multiple rental houses. If so, you can deduct the loss from one of them if the income covers it.
Special loss allowance
You can claim a special loss allowance for rental real estate activities that fall outside the general rule. This means you can take up to $25,000 in losses against non-passive income. You must be an active participant in the activity to qualify.
There’s an exception to this rule. If you’re married filing separately, the amount is either:
- $12,500 if you didn’t live together
- $0 if you lived together in the year
Active participants are those involved in managing the property. This means you do things like:
- Approve new tenants
- Handle leases
- Make decisions about property maintenance
Your involvement must be significant and bona fide.
If your income goes up, the ability to take the special loss allowance can phase out. This happens if your modified adjusted gross income (AGI) is more than:
- $50,000 if you’re married filing separately and lived apart from your spouse all year
Vacation home rentals
You might own a home that you live in part of the year and rent out part of the year. If so, you’ll prorate the expenses you incur between personal and rental use.
To figure the ratio of personal and rental use:
- Figure the total days of use by adding together personal days and rental days for the year.
- Divide the number of days the home was rented by the total days of use.
Since vacation homes usually get this kind of treatment, the rules are known as the vacation home rules.
If you’d like to learn more, see the Vacation Home Income tax tip.
Rental of a former main home
If you convert your main home to rental property, you don’t need to apply the vacation home rules. This is true if you intend to keep the property exclusively for rental use. Once converted, don’t count days of personal use before the conversion date if either of these applies:
- You rented or tried to rent the property for at least 12 consecutive months.
- You rented or tried to rent the property for a period of fewer than 12 consecutive months. This applies if the period ended because you sold or exchanged the home.
However, this special rule doesn’t apply when you’re dividing expenses between rental and personal use.
Depreciation of converted rental property follows special rules. When you convert property from personal to business use, the basis for depreciation is the smaller of these:
- Adjusted basis on the date of conversion — most common
- Fair market value (FMV) on date of conversion — usually applies when property values are dropping
To figure how much depreciation you can claim, figure the basis of the property. The basis is usually how much you paid for the property. However, a part of that price applies to the land. You can only depreciate the rental home itself, not the land.
To figure how much the land is worth, get an appraisal of the property. The appraisal should separately state the FMV of the land and the building. You can estimate the value of the land based on the tax assessment statement for the year of conversion. Also, a local real estate firm might give you guidance on land values at the time you bought the land and on the conversion date.
Deduct your expenses in the year you pay them. You can deduct these — and other less common — expenses for your rental property:
- Auto and travel
- Cleaning and maintenance
- Legal and other professional fees
- Mortgage interest paid to banks and other financial institutions — They must be secured by the rental property.
- Real property taxes
- Depreciation expense
- Other expenses specific to your rental — Ex: condo fees or landscaping expenses
You might not use the rental property personally. If so, you don’t need to prorate your expenses between personal and rental use.
Reporting rental income
Report rental income on Form 1040, Schedule E, Page 1. Deduct rental expenses in the expenses section of Schedule E. To report rental income of property other than real estate, use:
- Form 1040. Other Income
- Schedule C (in some cases)
To learn more, see Publication 527: Residential Rental Property (Including Rental of Vacation Homes) at www.irs.gov.
Report royalties from:
- Oil, gas, or mineral properties — Don’t include operating interests.
If you received $10 or more in royalties in 2020, the payer should send you a Form 1099-MISC or similar statement. Contact the payer if you don’t receive this document by early February.
Report your royalty income and expenses on Schedule C if you’re in business as one of these:
- Self-employed writer
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