 Income tax 2022-2023, reporting rental income expenses and losses overview. Let's do some wealth preservation with some tax preparation. Most of this information comes from Publication 527 Residential Rental Property, including Rental of Vacation Homes Tax Year 2022. You can find on the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused on line one income. Remember, in the first half of the income tax formula is an essence and income statement. Although just an outline, other forms and schedules flowing into these line items, one of those, the Schedule E, an essence and income statement in and of itself, having rental income minus rental expenses. The net rental income flowing into line one income of the income tax formula. Reporting rental income expenses and losses. Clearly the first form that comes to mind when we think about income taxes is the Form 1040. Then we generally think about other forms and schedules that ultimately flow into the Form 1040. When most people think about rental income, we generally think about it as a kind of side hustle. Another type of business, it's going to be formatted in an income statement type of format where we have rental income minus the expenses that needed to be consumed in order to generate the income, which are basically business expenses, business deductions. Therefore, support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more, like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Why wouldn't we just report it on the Schedule C, which is where we report all other kinds of sole proprietor and contractor businesses for the most part? And the first answer that might come to mind is that, well, the rental property is going to have a whole different set of expense categories. So we have to have this whole other form just for the rental property where all other businesses kind of fit into the Schedule C form. That's not the primary purpose that we have to be breaking out the Schedule C to the rental property. With the rental property, we have this concept of kind of passive income, meaning you're not actively involved with the property. The property is basically generating income in and of itself in a similar fashion as like investment income. If you just put income, if you put money into like an investment stocks and bonds and you generate dividends and interest, you're not really actively working for it. And when we have the active working situation that are typically reported on the Schedule C, then we're also going to be subject to the Social Security and Medicare, the self-employment tax kind of situation. When we think about the rental income, we're thinking about the property itself oftentimes basically, you know, doing a lot of the work. And then there's a question of how active are you in engaging in the rental property? And that becomes more and more important, not when there's income, but when there's losses involved. Because when there's losses involved, the IRS is going to be kind of skeptical about the losses in part because there's another factor that's involved with the rental property for income generation. We're not just having the rental property most likely in order to get the rental income. We're also having the property because we expect the property to go up in value possibly just in terms of the location of the property, you know, if nothing else. So you have this situation where it could be actually beneficial from a taxpayer standpoint to have the rental property. If you have losses on the rental property to take the losses and report them against other income. So you reduce your taxes while the actual property value goes up in value. So you're actually generating income, which is not going to be realized and therefore subject to tax until you sell the rental property. So you have this whole other dynamic that makes it a little bit more confusing when you're thinking about rental property as opposed to like other side hustles where you're basically getting paid for your work, right? Getting paid for what you're doing at that point in time. So that's the general idea. So obviously we'll have a schedule E generally instead of a schedule C, there will be questions about how active the participation is. And then there's generally going to be possibly more rules with regards to limiting the amount of losses that you can take with respect to the rental property as opposed to like a schedule C type of situation. And then of course the self-employment situation, you might not be subject to self-employment tax if it's not a schedule C or fully active participation in the business situation. Okay, so figuring the net income or loss for a residential rental activity may involve more than just listing the income and deductions on schedule E form 1040. Obviously logistically that's the first step that's going to happen. We're going to have to get the bookkeeping done just like any other business. It's going to basically be an income statement. We're going to populate that income statement usually not into the schedule C but rather into the schedule E. And the schedule E only has an income statement. We don't typically have the balance sheet although we might have depreciation schedules that we have to deal with. There are activities that don't qualify to use schedule E such as when the activity isn't engaged in to make a profit or when you provide substantial services in conjunction with the property. So obviously if it wasn't engaged in for profit the reason that's a situation and we see this with the normal business income activity because if it's not engaged for profit then it's likely you're going to have losses and the IRS doesn't want to pay you for your hobby losses or something like that. And then if there's substantial services involved like if it was a hotel or something like that then you're not really just making passive money by just renting it out and collecting the rent on it. You are actually a lot of what you're doing in a hotel is providing the service of keeping up the hotel maintaining the hotel and all that kind of stuff. So now you are actively involved and you would think it might be more subject to like a schedule C and you might be subject to self-employment and that kind of stuff. So there are also limitations that may need to be applied if you have a net loss on schedule E. That's the big one. A lot of people often have might have losses because you would think the general planning when you're when you're dealing with rental income is not just to make money on the rental property possibly but you might have more long term plans for the property value to go up in the property. So you might be willing to sustain losses in the short run in order to own the property which you think will go up in value in the long run. So you can get more complex long term planning because of the structure of the rental property and that's and then the losses become kind of a messy situation. So there are two, one the limitation based on the amount of investment you have at risk in your rental activity and two the special limits imposed on passive activities. So you may also have a gain or loss related to your rental property from a casualty or theft. This is considered separately from the income and expense information you report on schedule E. So which forms to use? The basic form for reporting residential rental income and expenses is schedule E form 1040 rather than the schedule C. It looks much the same. It's an income statement type of form but it's for the rental property. However, don't use that schedule to report a not for profit activity. See not rented for profit later in chapter four. There are also other rental situations in which forms other than schedule E would be used. Schedule E form 1040. If you rent buildings rooms or apartments and provide basic services such as heat and light trash collection etc. You normally report your rental income and expenses on the schedule E. So notice it's not like with the rental property. It's not like you're doing nothing. You know you're still doing some providing some of the services but you're not. But hopefully the property the idea of the rental property is the property itself is going to be basically generating you know revenue and you might even hire obviously management companies to do some of this some of this other other stuff. But that's far less actual service than in like a hotel kind of situation. So list your total income expenses and depreciation for each rental property. So we're going to have breaking out our rental property and then we're not going to lump all the rental property together as if it was one business. Generally you're going to take each rental property and have another kind of schedule E basically income statement per property. So be sure to enter the number of fair rental and personal use days online too. So you know if you used it for personal use we may get into that later but we saw that that kind of money buddies up the situation because now you might have like a vacation property that you that you rented and you used for personal use. Now you've got to break out you know the business versus personal as opposed to a property that's three sixty five days a year rental which is you know more straightforward clearly. So if you have more than three rental or royalty properties complete and attached as many schedule E as are needed to separately list all the properties. However fill in lines twenty three eight through twenty six on only one schedule E. So in other words you're going to have a schedule E's as many as you need to do the income statement kind of format of the schedule E but then the bottom line of the schedule E the bottom part which is going to help to kind of figure your passive you know limitations and whatnot will kind of group together all the schedule E's will summarize together there. So in other words if you had one property that had income and another property had a loss you're going to you're going to you're going to report them separately but when you net them together then you might have had income right so so so then you might not be subject to any of the loss limitations in that case you can kind of you can generally net out for example two properties that are both kind of passive in nature you would think that you would be able to take the losses against the other property. The question would be can you take the other losses against other income like W2 income or something like that. Okay so the figure on lines twenty three eight through twenty six on the schedule E should be the combined totals of all properties reported on your schedule E on schedule E page one line eighteen into the depreciation you are claiming for each property you may also need to attach form four six I mean sorry four five six two to claim some or all your depreciation C form four five six two later for more information. So if you have a loss from your rental real estate activity you may also need to complete one or both of the following forms you got the form six nine I mean sorry six one nine eight those are the at risk limitations see at risk rules later also you can check out publication nine two five and then you've got the form eight five eight two these are the passive activity loss limitations and you can see passive activity limits later and we'll get into those in the next presentation. So page two of schedule E is used to report income or loss from partnership S corporation estates trusts and real estate mortgage investment conduits if you need to use page two of schedule E and you have more than three rental or royalty properties be sure to use page two of the same schedule E you use to enter the combined totals for your rental activity on page one also include the amount from line twenty six part one in the quote total income or loss in quote online forty one part five okay we'll take a look at forms later form four five six two who must complete an attached form four five six two if you are claiming the following depreciation in your rental activity so depreciation including the special depreciation allowance on property placed in service during two thousand twenty two so if you have special depreciation which is we talked a little bit when we when we went over depreciation is like that upfront depreciation for certain types of property might qualify for then you'd have to attach another form for that depreciation on listed property such as a car regardless of when it was placed in service otherwise figure your depreciation on your own worksheet you don't have to attach these computations to your return but you should keep them in your records for future reference those depreciation schedules do become important usually they're going to be generated with the help of tax software it's kind of interesting to me that sometimes they don't require the schedules the because you would think you think they want the you know but obviously if you're picking up a new client that becomes an issue because if you get it if you get the prior your tax return if it doesn't include the depreciation schedules then that's going to be a problem because those things are going to be you know needed for a long period of time so whenever you pick up a new client or something like that if you're doing rental property or anything with depreciation I would suggest you want to make sure you get that depreciation schedules from the prior return and that you that that then you enter the prior return depreciation schedules trying to match what was reported in the prior year and then roll it forward into the current year so that the software can kind of help you out you may also need to attach form four five six two if you are claiming a section one seventy nine deduction that's another one of those upfront like the special deduction amortizing costs that began during two thousand twenty two or claiming any other deduction for a vehicle including the standard mileage rate or lease expenses you can see publication nine four six for information on preparing form four five six two schedule C so usually we report on the schedule E now we're looking schedule C the normal business form for sole proprietors profit or loss from business generally schedule C is used when you provide substantial services in conjunction with the property or the rental is part of a trade or business as a real estate dealer so now you can see what's happening here and you can see the difference because you can say okay it's still it's still like rental property is basically involved and and this is why we can see it's not just that the expenses are different for rental properties why we put it on the schedule E because there are situations where you might use the schedule C when you still have you know the similar kind of expense situation it's the fact that when you move to the schedule E you may be doing so because there's this generally passive activity factor if you're actively involved in the business then in a more active way then you're providing more services for example then you might report it on a schedule C in that case and if you report on the schedule C it's going to be business income subject to the self-employment tax and all that kind of stuff although most likely not subject to the same kind of passive limitations and what not when you have losses in that situation and you can and just note that you can kind of see the back and forth when you see the regulations with the IRS because you can see generally you can see the IRS basically saying at one time hey look you rental people are taking advantage of rental property reporting massive losses and it's basically passive kind of activity and then they jumped in and said I'm just going to call it passive activity all rental activity is passive all of a sudden and that was kind of a huge hit and then of course people that are actually in the business with real estate came back and said hey wait a second I'm actually not having passive income I actively participate in this thing and you're limiting my business more than other businesses other than rental income and then you can see this compromising kind of situation that ends up happening where we have all these different rules on what qualifies as passive and active and kind of middle in between for the rental property so again generally schedule C is used when you provide substantial services in conjunction with the property or the rental is part of a trade or business as a real estate dealer providing substantial was a substantial loss for the company so if you provide substantial services that are primarily for your tenants convenience such as regular cleaning changing linen or made service you report your rental income and expenses on the schedule C because now you're doing a lot of service items within it use form 1065 U.S. return of partnership income if your rental activity is a partnership including a partnership with your spouse unless it is a joint venture so we get into that partnership kind of situation with the spouse which gets a little bit a little bit confusing because you would think you would be reporting as one entity with the schedule E but it gets a little bit messy because you actually have two people involved and so note that if it's actually your business if it's a business income and you're reporting schedule E I mean schedule C then the question is well is it possible to have a you might have different rules for a community property state to kind of split out the schedule C versus non-community property states and it also becomes important to properly allocate the self-employment and Medicare tax that's where it gets messy with the schedule C because the benefits that you will be receiving will be dependent upon how much you paid in that was allocated to the social security social security primarily substantial services don't include the furnishing of heat and light cleaning of public areas trash collection etc so in other words if you're if in your rental property you're furnishing heat and light it's pretty passive it's not like you're actively cleaning of public areas meaning you're not going into the place into the hotel or something and cleaning it by cleaning the public areas trash collection which again is outside that's you know etc that's not the active participation that would kick you over from doing the schedule E to the schedule C the schedule E usually be what you want to be doing if you can into for most cases because it's well there's pros and cons but the pros would be you might not be subject to the self-employment tax and the cons are that you've got the limitations on the losses so also you may have to pay self-employment tax on your rental income using schedule S E self-employment tax for discussion of substantial services see real estate rents in chapter 5 of publication 334 qualified joint venture if you and your spouse each materially participate participate in see material participation under passive activity limits later as the only members of a jointly owned and operated real estate business and you file a joint return for tax year you can make a joint election to be treated as a qualified joint venture instead of a partnership that will usually be easier because in that situation you don't have to file a partnership return which would be a separate return from the 1040 individuals and then have it flow into your joint individual return that's going to cost more be more some if you're a partnership and you would think with the rental property you would be able to do that it would be easier to do especially if you don't have to deal with that added issue of the self-employment tax on the schedule E as opposed to the schedule C where you do have to okay so this this election every election in most cases won't increase the total tax owed on the joint return but it does give you each credit for social security earnings on which retirement benefits are based and the medical coverage is your rental income is subject to self-employment tax so if you're reporting on a schedule C then that becomes quite important to get that breakout proper if you make this section if you make this election you must report our rental real estate income on schedule E or schedule C if you provide substantial services you won't be required to file form 1065 the partnership return for any year the election is in effect rental real estate income generally isn't included in net earnings from self-employment subject to self-employment tax is generally subject to the passive activity limits so if you and your spouse filed a form 1065 for the year prior to the election the partnership terminates at the end of the tax year immediately proceeding the year the election takes effect so if you file the tax return or say I don't need this partnership tax return we're going to drop that then the partnership should basically dissolve hopefully and so now you'll be reporting it on the schedule C so once again if you and your spouse file the form 1065 partnership return for the year prior to the election the partnership terminates at the end of the tax year immediately proceeding the year the election takes place so for more information on qualified joint investors you can go to irs.gov for slash IQJV