Unit 9 - Rental And Royalty Income

Question 1

What is rental income and examples?

Answer 1

Any payment received for the use or occupancy of physical property

Residential rentals
Lodging at hotels and motels
Commercial rentals
Car rentals
Machinery rentals

Question 2

What is royalty income and examples?

Answer 2

A form of income received for the use of another person‘s property

Patents
Copyrights
Timberland
Oil and gas wells
Copper mine

Question 3

Where do you report rental income and royalty income on a tax return

Answer 3

Schedule E (supplemental income and loss) of form 1040 with some exceptions

Question 4

Rental Income - what expenses can you deduct

Answer 4

1. Interest on mortgage payments and property taxes.
2. Maintenance, lawn, care, repairs, and cleaning services.
3. Expenses for advertising vacancies.
4. Utilities that are covered by the owner – such as sewer or trash.
5. Insurance premiums for home, liability, and natural disaster coverage.
6. Depreciation.

Question 5

Advanced rent – when do you report it?

Answer 5

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

Question 6

Lease cancellation – how is the money reported

Answer 6

Money received for a lease cancellation is considered rental income

Included in the year received for tax

Question 7

Refundable security deposits – how is it classified/reported

Answer 7

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

Question 8

Insurance premiums paid in advance - how is the expense deducted?

Answer 8

If the insurance premium covers multiple years…

You can only deduct the portion of the payment that applies to the current year

Question 9

Receiving property or services in Lou of rent - how is it reported?

Answer 9

The fair market value must be recognized as rental income

Unless there was an agreed-upon price in advance

Question 10

When a tenant pays expenses on behalf of the landlord… how is it reported?

Answer 10

The landlord must recognize the payments as rental income

The property owner can also deduct the expenses as rental expenses

Question 11

Vacant rental property – how do you report loss of rental income or deduct expenses?

Answer 11

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

Question 12

Idle property and deducting expenses

Answer 12

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

Question 13

Rental property - making repairs before placing the property into service

Answer 13

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

Question 14

When can you deduct depreciation of a rental property?

Answer 14

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

Question 15

Factors that determine how much depreciation a landlord can deduct

Answer 15

The properties basis

The recovery period for the property

The depreciation method used

Question 16

What is the depreciation recovery period For residential rentals and non-residential buildings

Answer 16

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

Question 17

Calculating depreciation on a rental property

Answer 17

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

Question 18

Converting a home to rental use – what is the basis used for depreciation?

Answer 18

The lessor of…

The fair market value

Or the adjusted basis on the date of conversion

Question 19

Section 179 deduction – what is it?

Answer 19

An immediate expense deduction that allows business owners to fully depreciate business property in the first year

Question 20

Section 179 deduction – what rental properties qualify

Answer 20

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

Question 21

Mixed use buildings

What are they and how are they depreciated?

Answer 21

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

Question 22

Repairs versus improvements to rental property

What are they and how are they expensed?

Answer 22

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

Question 23

Rental improvements - de minimus, safe harbor rule

Answer 23

Tax American elect to expense, tangible property costing no more than 2500 in the year they are used or consumed instead of depreciating

Question 24

SHST

Answer 24

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

Question 25

Deducting rental losses

Answer 25

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

Question 26

Special $25,000 loss allowance rule for real estate rental activities

Answer 26

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

Question 27

MAGI defined

Answer 27

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

Question 28

Special $25,000 loss allowance rule – married filing separately

Answer 28

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

Question 29

Special $25,000 loss allowance – the following taxpayers are not allowed to claim the special loss allowance

Answer 29

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

Question 30

Special $25,000 loss allowance – calculating the allowance if MAGI is more than $100,000

Answer 30

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

Question 31

Reporting partial ownership of a rental property

Answer 31

Report share of rental income, and share of deductible expenses on schedule

Question 32

When renting only part of a property… What expenses can you deduct?

Answer 32

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

1. The number of rooms in the house.
2. Or the square footage of the house.

The remainder is expensed on schedule a

Question 33

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?

Answer 33

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 …

1. Deemed to be a personal residence.
2. Rental activity is a partial rental activity.
3. The owners rental expense exceed rental income.

Cannot use the excess expense to offset income from other sources – it will carry forward

Question 34

Not for profit rentals

How is income and losses reported?

Answer 34

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

Question 35

Below market rentals

How is income and losses reported?

Answer 35

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

Question 36

Minimal rental use – 15 day rule

Answer 36

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

Question 37

Requirements to be classified as a real estate professional

Answer 37

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

Question 38

Special rules for real estate professionals

Answer 38

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

Question 39

Hotels, motels and bed-and-breakfast

Reporting rental income

Answer 39

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

Question 40

Personal property rentals – what are they? Where are they reported?

Answer 40

The rental of personal property, such as vehicles, equipment, formal wear, camper…

Reported on schedule C if the activity is a trade or business

Question 41

Personal property rentals by taxpayers who are not in the business of renting personal property

Answer 41

Report the income online 8L and expenses online 24B of schedule 1

Expenses are limited to the income from the activity

Question 42

Royalty income – Natural resource royalties

Answer 42

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

Question 43

Royalty income – copyrights on literary, musical, or artistic works

Answer 43

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

Question 44

Royalty income – special rules for self-employed writers, musicians, and inventors

Answer 44

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