Section 2: Income & Assets Unit 9: Rental & Royalty Income

Question 1

Rental & Royalty Income tax form

Answer 1

Sch E

Question 2

If the security deposit is refundable, when is it income for the landlord?

Answer 2

NOT at the time upon rental. Only recognized as income in the year that it is constructively received if tenant owes you for repairs, etc.

Question 3

When can you start deducting expenses for a new rental property?

Answer 3

Once it is available and advertised for rent. You cannot deduct expenses in a year where you have not made the rental available for rent. Any repairs made before it is available for rent must be added to the property’s BASIS instead of deducting.

Question 4

Residential rentals are depreciated over ____ years.

Non Residential rentals are depreciated over ___ years.

Answer 4

Residential rentals are depreciated over 27.5 years.

Non Residential rentals are depreciated over 39 years.

Question 5

“Active Participation”

Answer 5

Must own at least 10% of rental property AND make management decisions

Question 6

Special Loss Allowance

Answer 6

$25,000 loss allowance against nonpassive income

• Must be actively managing
• MFJ or SINGLE: $100K MAGI limit
• MFS and LIVES TOGETHER at any point of the year: $0 allowance
• MFS and does NOT live together during any part of the year: $12,500 against $50K MAGI

Any losses that you cannot take push forward to the next year (“suspended losses”) or until you can use them against your nonpassive income OR you have a fully taxable sale of the property (i.e. to a nonrelated party)

Question 7

If you have a property that you rent out for LESS than 15 days, it is

Answer 7

non-taxable. no matter then amount.

Question 8

Personal Property
If you are in the business of rentals, file the income on:

If you are not in the business of rentals, file the income on:

Answer 8

Personal Property
If you are in the business of rentals, file the income on: Sch C

If you are not in the business of rentals, file the income on: 1040, additional income & adjustments page

Question 9

Threshold for issuing a 1099-MISC for royalties

Answer 9

$10

Must be reported on Sch E

Question 10

Where would an artist file their income from royalties? (Writer, painter, etc)

Answer 10

Sch C (Business Income & Losses)
They are also subject to SE tax.

Once the copyright is inherited, is it no longer subject to SE tax.

Question 11

Question ID: 94849626 (Topic: Rental Property and Income)
LuAnn rents a room in her home to a college student for nine months of the year. The student pays $600 a month in rent. The home has five rooms in the house. Each room is approximately the same size. LuAnn paid the following expenses in the current year:

Mortgage interest: $9,000
Homeowner’s insurance: $1,000
Property taxes: $2,000
Utilities: $1,000
What amounts should LuAnn report as rental income and deduct as rental expenses on her Schedule E?

A. Rental income: $5,400; deduction: $1,950.
B. Rental income: $5,400; deduction: $2,600.
C. Rental income: $5,400; deduction: $13,000.
D. Rental income: $3,450; deduction: $0.

Answer 11

Correct Answer Explanation for A:

LuAnn must report the full amount of rental income collected: (9 × $600 =$5,400). Her expenses total $13,000. Because the student uses one-fifth (20%) of her house, she can deduct 20% of the expenses ($13,000 × .20 = $2,600), but only for the nine months during which the student rented the room. Thus, the expenses must be further allocated for the period of occupancy (9/12 months = 75% × $2,600 = $1,950).

A taxpayer who rents part of a property must divide certain expenses between the part of the property used for rental purposes and the part used for personal purposes, as though there were actually two separate pieces of property. Expenses related to the part of the property used for rental purposes can be deducted as rental expenses on Schedule E. This includes a portion of expenses that normally are nondeductible personal expenses, such as painting the outside of a house. If an expense applies to both rental use and personal use, such as a heating bill for the entire house, the taxpayer must allocate the expense between the two. The two most common methods for allocating such expenses are based on:

The number of rooms in the house, and
The square footage of the house.

Question 12

Question ID: 94850305 (Topic: Rental Property and Income)
Joshua is unmarried and works full time as a college professor. He is not a real estate professional, but he does own a residential rental that he manages himself. Joshua earned $120,000 in salary at his job, and a ($31,000) loss from his rental real estate activities in which he actively participated. He reports the rental on Schedule E. He had no other income or loss for the year. Based on this information, figure out his passive loss carryover.

A. $31,000
B. $16,000
C. $6,000
D. $15,000

Answer 12

Correct Answer Explanation for B:

When Joshua files his return, he can deduct only $15,000 of his passive activity loss. He must carry over the remaining $16,000 passive activity loss to the following year. He must figure his deduction and carryover as follows:

Adjusted gross income $120,000
Minus amount not subject to phaseout ($100,000)
Amount subject to phaseout rule $20,000

Multiply by 50% X 50%
Reduction to “special allowance” $10,000
Maximum “special allowance” $25,000
Minus reduction $10,000

Adjusted “Special allowance” $15,000
Passive loss from rental activity $31,000
Deduction allowable in the current year ($15,000)

Amount of losses that must be carried forward $16,000
Based directly on an example in Publication 925.

Question 13

Phaseout rule for $25K special allowance.

Answer 13

The maximum special allowance of $25,000 ($12,500 for married individuals filing separate returns and living apart at all times during the year) is reduced by 50% of the amount of your MAGI that’s more than $100,000 ($50,000 if you’re married filing separately). If your MAGI is $150,000 or more ($75,000 or more if you’re married filing separately), you generally can’t use the special allowance. This is because the special allowance is reduced to $0 since the MAGI is over the $100,000 amount.

Question 14

Question ID: 94850303 (Topic: Rental Property and Income)
Thomas owns a rental property in Miami, Florida, that he rents out to short-term tenants. Thomas provides services like fresh linens, fresh towels daily, and a complimentary breakfast for his guests. What form should he report this income?

A. Schedule E
B. Schedule D
C. Schedule C
D. Schedule F

Answer 14

Correct Answer Explanation for C:

Thomas should report the rental income on Schedule C. If a property owner provides “substantial services” to short-term renters, the IRS says that the rental activity should be reported on Schedule C. The IRS defines substantial services as services generally provided to guests that are primarily for their convenience and not normally provided with a rental. For example, meals, daily laundry, and maid services.

Question 15

Question ID: 94849651 (Topic: Rental Property and Income)
Norbert purchased his home six years ago for $250,000. The purchase price was allocatable to fair market values of (1) $50,000 for the underlying land and (2) $200,000 for the house. Norbert paid an additional $18,000 for adding an additional bathroom to the home. Norbert moves out of the home on June 1, because of a job transfer. Instead of selling the home, he decides to rent it out. A tenant moved in on October 1, 2023. The FMV of the property on October 1 was $310,000, comprised of $65,000 for the land and $245,000 for the house. He paid $2,400 for plumbing repairs during November after his tenant discovered a water leak in the garage. Based upon the information listed, what is the basis on which depreciation should be calculated during the rental period?

A. $270,400
B. $245,000
C. $250,000
D. $218,000

Answer 15

Correct Answer Explanation for D:

The basis for depreciation is the lesser of fair market value or the taxpayer’s adjusted basis on the date the property was converted to rental use. The adjusted basis on October 1 was $218,000 (original cost of $200,000 + improvements of $18,000). Since this amount was lower than the FMV of the home ($245,000) on the same date, the lower figure must be used as the basis for depreciation on the property. The basis of the land is not subject to depreciation (land is never depreciated). The plumbing repairs are deductible as a current expense and are not depreciated. Instead, the repairs would simply be deductible as an expense on Schedule E.

Question 16

Question ID: 94815968 (Topic: Rental Property and Income)
Cecile is a limited partner in two different partnerships. Cecile also owns a residential rental that she manages herself, but she is not a real estate professional. All the activities generated a profit for the year. Where should Cecile report the income she receives from these activities?

A. The pass-through income from the partnership would be reported on Schedule C. The rental would be reported on Schedule E.
B. All the income should be reported on Schedule E.
C. All the income should be reported on Schedule C.
D. The pass-through income from the partnership would be reported on Schedule D. The rental would be reported on Schedule E.

Answer 16

Correct Answer Explanation for B:

All the income should be reported on Schedule E (Form 1040). Taxpayers use Schedule E to report income (or loss) from rental real estate, royalties, partnerships, S corporations, estates, trusts, and residual interests in REMICs.

Question 17

Question ID: 94815999 (Topic: Rental Property and Income)
Marcas is a Canadian resident and citizen who owns a profitable rental property in the United States that nets $50,000 in rental income per year. He is not currently a citizen or resident of the United States, but he has a Social Security number because he worked in the United States decades ago. How should Marcas report his rental income?

A. Marcas should file Form 1040.
B. Since he has a valid SSN, Marcas can choose whether to file Form 1040-NR or Form 1040.
C. Marcas does not need to file any U.S. tax return.
D. Marcas should file Form 1040-NR.

Answer 17

Correct Answer Explanation for D:

In order to report his income, Marcas will need to file Form 1040-NR. Just because someone has an SSN, doesn’t mean they are a resident of the U.S. for tax purposes. Many nonresident aliens have a Social Security number for various reasons.

Question 18

Question ID: 94849700 (Topic: Rental Property and Income)
Ignatius owns one-half of a residential rental house. His cousin, Marina, owns the other half. The house is rented out all year to long-term tenants. Last year, Ignatius paid $968 out of pocket for repairing a broken water pipe on the property. How should this expense be treated on his tax return?

A. He can deduct $484 (50% × $968) as a rental expense on Schedule E. He is entitled to reimbursement for the remaining half from the co-owner.
B. He can deduct $484 (50% × $968) as a rental expense on Schedule E. The other 50% he can claim as an adjustment to income on his Form 1040.
C. He can deduct $968 as a business expense on Schedule C.
D. He can deduct $968 as a rental expense on Schedule E.

Answer 18

Correct Answer Explanation for A:

If you own a part interest in rental property, you can deduct expenses you paid according to your percentage of ownership. Therefore, Ignatius can deduct $484 (50% X $968) as a rental expense. He is also entitled to reimbursement for the remaining half from the co-owner. See Publication 527, Residential Rental Property, for more information and to see similar examples.

Question 19

What is the tax treatment of royalties?

A. Taxable as ordinary income
B. Taxable as capital gains
C. Taxable as passive activity income
D. Exempt from taxation

Answer 19

Correct Answer Explanation for A:

Royalties from copyrights, patents, and oil, gas and mineral properties are taxable as ordinary income. Royalties are generally reported on Schedule E. For example, natural resource royalties are paid for the extraction of natural resources, like timber, oil, gas, and minerals. The owner of the land or mineral rights typically receives a royalty based on the value of the resource extracted.

Question 20

Question ID: 95850169 (Topic: Royalty Income)
How are royalties from natural resource extraction, such as mining activities, typically reported?

A. On Schedule C
B. On Schedule A
C. On Schedule D
D. On Schedule E

Answer 20

Correct Answer Explanation for D:

Royalties from natural resource extraction are typically reported on Schedule E (Supplemental Income and Loss).