Unit 9 - Rental And Royalty Income Flashcards
What is rental income and examples?
Any payment received for the use or occupancy of physical property
Residential rentals
Lodging at hotels and motels
Commercial rentals
Car rentals
Machinery rentals
What is royalty income and examples?
A form of income received for the use of another person‘s property
Patents
Copyrights
Timberland
Oil and gas wells
Copper mine
Where do you report rental income and royalty income on a tax return
Schedule E (supplemental income and loss) of form 1040 with some exceptions
Rental Income - what expenses can you deduct
- Interest on mortgage payments and property taxes.
- Maintenance, lawn, care, repairs, and cleaning services.
- Expenses for advertising vacancies.
- Utilities that are covered by the owner – such as sewer or trash.
- Insurance premiums for home, liability, and natural disaster coverage.
- Depreciation.
Advanced rent – when do you report it?
When it is constructively received, without restrictions
If received in December for a January rent – you would report it on the previous year tax return
Lease cancellation – how is the money reported
Money received for a lease cancellation is considered rental income
Included in the year received for tax
Refundable security deposits – how is it classified/reported
When the initial refundable deposit is received – it is not considered income (liability)
If the property owner keeps some or all of the deposit because the tenant did not live up to the terms – it is recognized as income in that year
Insurance premiums paid in advance - how is the expense deducted?
If the insurance premium covers multiple years…
You can only deduct the portion of the payment that applies to the current year
Receiving property or services in Lou of rent - how is it reported?
The fair market value must be recognized as rental income
Unless there was an agreed-upon price in advance
When a tenant pays expenses on behalf of the landlord… how is it reported?
The landlord must recognize the payments as rental income
The property owner can also deduct the expenses as rental expenses
Vacant rental property – how do you report loss of rental income or deduct expenses?
Property owner cannot claim a loss of rental income for any period of time when the property is unoccupied
But as long as the property is available, ready, and advertised for rent – the owner can deduct expenses, including depreciation, even if the property is unoccupied
Idle property and deducting expenses
When a landlord must make repairs after a tenant moves out - and the property will be vacant
Assuming the rental property had already been placed in service as a rental
The landlord can still deduct expenses, including depreciation during this time
Rental property - making repairs before placing the property into service
The repairs must be capitalized and included in the properties basis
Expenses can only be deducted once the property is placed into service for the production of rental income
When can you deduct depreciation of a rental property?
The landlord can start claiming deductions for the depreciation once the rental property is put into service for generating income
Depreciation stops when the landlord has either fully recouped their cost or basis or when the property is no longer in use, whichever comes first
Factors that determine how much depreciation a landlord can deduct
The properties basis
The recovery period for the property
The depreciation method used
What is the depreciation recovery period For residential rentals and non-residential buildings
Residential rentals are depreciated over 27.5 years
Non-residential buildings are depreciated over 39 years – with a half months worth of depreciation allowed for the first and last month of the depreciable life of the property
Calculating depreciation on a rental property
Only applies to the building never the land
Take the total basis amount divided by the number of years equals the amount of depreciation per year
Converting a home to rental use – what is the basis used for depreciation?
The lessor of…
The fair market value
Or the adjusted basis on the date of conversion
Section 179 deduction – what is it?
An immediate expense deduction that allows business owners to fully depreciate business property in the first year
Section 179 deduction – what rental properties qualify
Residential rental properties do not qualify
Includes expenditures for non-residential buildings and non-residential commercial property
Office buildings
Medical centers
Hotels
Malls
Roofs and heating and ventilating
Air conditioning equipment, fire protection, and alarm systems
Security systems
Mixed use buildings
What are they and how are they depreciated?
Buildings that are used to generate residential rental income and commercial income
If 80% or more of the annual gross rental income is generated from the residential rental the building structure components are classified as residential rental property and depreciated over 27.5 years
If the building does not meet the 80% test – the entire building and improvements are depreciated over 39 years
Repairs versus improvements to rental property
What are they and how are they expensed?
A repair keeps an asset or property in good working condition, but does not add to the value of the asset – fully deductible in the year they are paid
Improvements are major expenditures that go beyond normal repairs - need to be capitalized (separately) and depreciated overtime
Improvements is also considered the betterment of a property
Rental improvements - de minimus, safe harbor rule
Tax American elect to expense, tangible property costing no more than 2500 in the year they are used or consumed instead of depreciating
SHST
Safe harbor election for small taxpayers
Applies to landlords who own rental properties
Allows landlords to expense the total amount paid for repairs, improvements, and similar expenses in the year rather than depreciate
As long as it does not exceed the lesser of $10,000 or 2% of the unadjusted basis of the building
Deducting rental losses
The deductibility of losses from passive activities is limited
Rental activities are generally considered passive activities
Losses from passive activities that exceeded income from passive activities in the same year are disallowed
The disallow losses are carried forward to the next taxable year
There is a special $25,000 exception rule
Special $25,000 loss allowance rule for real estate rental activities
If a landlord is actively involved in managing the rental property – they may be eligible to deduct up to $25,000 of losses from their non-passive income, such as wages or self-employment
Subject to an income phase out
Full $25,000 allowance available to taxpayers with a modified adjusted gross income of $100,000 or less regardless of filing status
Only applies to passive rental activities and not other types of passive activities
MAGI defined
Taxpayers adjusted gross income with certain deductions added back in
May include IRA contributions, rental losses, student loan, interest, and qualified tuition expenses
MAGI is used as a basis for determining whether one qualifies for certain tax deductions
Special $25,000 loss allowance rule – married filing separately
If the couple is still together and files separately – neither can deduct any rental losses from passive income. The entire rental loss must be carried forward to future years.
If the couple lived apart from this house for the entire tax year, the special allowance for rental losses cannot exceed 12,500 and only be available if the taxpayers MAGI $50,000 or less
Special $25,000 loss allowance – the following taxpayers are not allowed to claim the special loss allowance
A limited partner in a business or activity
A property owner who has less than 10% ownership in a rental activity
A trust or corporation
Special $25,000 loss allowance – calculating the allowance if MAGI is more than $100,000
The loss allowance decreases by one dollar for every two dollars above the threshold
If the MAG reaches $150,000 or higher, the $25,000 allowance is phased out
any losses must be carried over to future years
Reporting partial ownership of a rental property
Report share of rental income, and share of deductible expenses on schedule
When renting only part of a property… What expenses can you deduct?
Only expenses related to the rental portion of the property
If an expense applies to both the rental use in personal use – need to divide it out
If the expense applies solely to the rental unit – it’s fully deductible
Most common methods for dividing the expenses are based on
- The number of rooms in the house.
- Or the square footage of the house.
The remainder is expensed on schedule a
Partial rental activity – with a profit motive
(Owning a vacation home that you rent out when you’re not there)
What qualifies and how are expenses deducted?
Is the Home considered a residence?
Considered a residence if the owner uses the property for personal purposes during the year for more than the greater of 14 days or 10% of the total days, it is rented at a fair rental price
Personal use includes when a member of the family stays in the property without paying rent or anyone staying for less than fair rental price
If the property is …
- Deemed to be a personal residence.
- Rental activity is a partial rental activity.
- The owners rental expense exceed rental income.
Cannot use the excess expense to offset income from other sources – it will carry forward
Not for profit rentals
How is income and losses reported?
Taxpayer cannot claim any rental expenses that exceed the rental income
Any unused expenses on a not for-profit rental cannot be carried forward to the following year
Not reported on schedule – not for profit rental income is reported on form 1040 as other income (line 8J – activity not engaged in for profit income)
If itemizing deductions mortgage interest in real estate taxes on schedule a
Below market rentals
How is income and losses reported?
Example is renting to a family member or another related party
Treated the same way as not for profit rental
Reported as other income on form 1040
Losses cannot exceed rental income, and they do not carry forward
Minimal rental use – 15 day rule
Taxpayer rents a main home or vacation home that is considered a residence for fewer than 15 days a year
Do not have to recognize any of the income as taxable
Homeowner also cannot deduct any expenses related to the rental of the property during this. Period.
Including cost, such as maintenance, utilities, insurance, and repairs
Requirements to be classified as a real estate professional
Taxpayer must provide more than 1/2 of their total personal services in real property trades (if they work two jobs they need to spend more than 50% on real estate)
And
Perform more than 750 hours of services during the tax year as a real estate agent
The taxpayer must own more than 5% of any activity for it to be considered under the real estate professional rules
Special rules for real estate professionals
If they qualify as a real estate professional…
any losses from rental real estate activities, where they actively participate are not classified as passive and can be deducted in full without any limitations
Hotels, motels and bed-and-breakfast
Reporting rental income
Owners of property who provides substantial services such as maid, cleaning and housekeeping services, laundry services, breakfast…
Revenue and expenses are reported on schedule C, not schedule E
Subject to self-employment tax
Personal property rentals – what are they? Where are they reported?
The rental of personal property, such as vehicles, equipment, formal wear, camper…
Reported on schedule C if the activity is a trade or business
Personal property rentals by taxpayers who are not in the business of renting personal property
Report the income online 8L and expenses online 24B of schedule 1
Expenses are limited to the income from the activity
Royalty income – Natural resource royalties
Payments received 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
Taxpayer receives a form 1099 – MISC
Reported on schedule E and not subject to self-employment tax
Royalty income – copyrights on literary, musical, or artistic works
Authors receiving a royalty for each book sold
Musician receiving a royalty for each song downloaded
Royalty payments are reported to the taxpayer on form 1099 – MISC
Reported on schedule E
Royalty income – special rules for self-employed writers, musicians, and inventors
These taxpayers must report their royalty income on schedule C and the income is also subject to self-employment tax
Because their personal efforts created the property
