 Income tax 2021-2022 reporting rental income expenses and losses part number two. Get ready to get refunds to the max diving into income tax 2021-2022. Most of this information can be found in publication 527 residential rental property tax year 2021 IRS website irs.gov irs.gov Income tax formula we're focused on line one income but we would have a sub schedule basically an income statement with income and expenses expenses basically being deductions the net then is what rolls in to line one income of the income tax formula and eventually page one of the form 1040. This is the schedule is basically the income statement schedule the supplemental income and loss we're focusing in on the rental real estate. So we're continuing on here with limits on rental losses so when we have the losses with regards to any kind of losses you got to think the government is going to be more skeptical of the losses because the government wants to be your silent partner when you have income but like if you have a loss they don't want to pay you on the loss they don't want to allow you to deduct the loss against other types of incomes although you may be able to in some instances but you can see how they'd be a bit skeptical of the losses especially with the rental income because with the rental income we're often not just engaging in that practice of rental property just to get the rental income we're also engaging in it because we might be hoping that the property goes up in value over time and then if we take losses on the property and then the increase in the property happens again the IRS could be more skeptical on rental property with regards to losses than possibly other businesses like service businesses for example. So if you have a loss from your rental real estate activity two sets of rules may limit the amount of loss you can report on schedule E. You must consider these rules in the order shown below both are discussed in this section. So number one you've got the at risk rules. These rules are applied first if there is investment in your rental real estate activity for which you aren't at risk. This applies only if the real property was placed in service after 1986 and then number two you've got the passive activity limits generally rental real estate activities are considered passive activities and losses aren't deductible unless you have income from other passive activities to offset them. So in other words on the passive activity you're trying to basically say that we're going to limit your passive activity losses and you have to wait until you have other income related to passive activity to take the losses as opposed to taking the losses against active activities such as say W2 income. So however there are exceptions as we'll see. So excess business loss limitations in addition to at risk rules and passive activity limits excess business loss rules apply to losses from all non corporate trades or businesses. The business loss limitation is figured using form 4 6 1 after you complete your schedule E any limitation on your loss resulting from these rules will not be reflected on your schedule E instead it will be added to your income on form 1040 and treated as a net operating loss that must be carried forward and deducted in a subsequent year. So if you got a limitation on the loss then the question is well what happens at that point in time. Does the loss just go away. Do I not get any benefit from it or do I get to roll it forward into a future period possibly and possibly take it against other kind of income and so on and so forth which is that's the that's the thing you would be thinking. So if you got a loss you can say I got a loss is the loss limited if the losses limited do I lose the loss or do I get to carry the loss forward if you do get to carry the loss forward then it's nice like if you're a tax professional to be using the same tax software or in other words you've got a more complex return. So if you were taking on a 2021 return for example for a new client you would probably want to take the full tax the tax return of the prior year enter into your 2020 software so that you can mirror exactly what happened on the prior year tax return and then roll it forward in the software the software helping with these limitations and any kind of carry forward that would take place on with the limitation. So at risk rules what are they you may be subject to at risk rules if you have a loss from an activity carried on as a trader business or for the production of income and amounts invested in the activity for which you aren't fully at risk losses from holding a real property other than a mineral property placed in service before 1987 aren't subject to the at risk rules and most cases any loss from an activity subject to the at risk rules is allowed only to the extent of the total amount you have at risk in the activity at the end of the year. You are considered at risk in an activity to the extent of cash and the adjusted basis of other property you contributed to the activity and certain amounts borrowed for use in the activity any loss that is disallowed because of the at risk limits is treated as a deduction from the same activity in the next tax year you could see publication 925 for discussion of at risk rules find that on the IRS website form 6198 if if you are subject to the at risk rules file form 6198 so quick look at that form. So here's your form 6198 at risk limitations you can obviously look at the instructions as well as the publication on the IRS website for more information so if you are subject to at risk file form. 6198 with your tax return so then we have the passive activity limits in most cases all rental real estate activities except those of certain real estate professionals discussed later are passive activities. So the real estate was basically put into this category of being passive activities and so and that means they're going to be subject. So when you think of passive activities you're basically thinking about those losses again if you have income. The passive activities don't really come into play because the IRS is happy to just take some of your income if there's income if there's losses then the IRS is skeptical they're saying hey it's a passive activity and you might have limitations then on the losses and to have that general requirement of being able to kind of match the losses from passive activity to income from passive activity not matching it up to income from non passive activity such as basically W2 type of income that's the general rule. Now you can imagine that many people that worked in the real estate profession started to say well hey wait a second other people get to take to get to take losses in their business like any other business gets a loss. Why are we being being excluded from that and so now you've got these kind of compromises that basically took places. So you hear these terms like if you are real estate professional into place and you might get some of the passive activities if you actively participate. So now you got these terms of active participation and real estate professional which of course then we have to define what that means because they could have different tax consequences. So for this purpose a rental activity is an activity from which you receive income mainly for the use of tangible property rather than for services. So we're not you know if it was services you'd be doing an active kind of thing if you provide services then of course you're doing something active and you're not basically just getting passive income from the renting of the property. So for a discussion of activities that aren't considered rental activities you can see rental activities in publication nine to five deductions or losses from passive activities are limited. You generally can't offset income other than passive income with losses from passive activity nor can you offset taxes on income other than passive income with credits resulting from passive activities. Any excess loss or credit is carried forward to the next tax year. So you're kind of limited you're kind of in the lane of passive activities with regards to taking advantage of your losses and netting them out against income. But you can't net them out against what's in the other lane of a type of income which is like normal income like W2 type of income. But if you can't match your losses up against income you might be able to do it in the future. Ruling the laws forward to hopefully have passive income in the future that you can net your loss that you couldn't take before because it was passive to the income that you might have in future time friends. So exceptions to the rules for figuring passive activity limits for personal use of a dwelling unit and for rental real estate with active participation. So there's another key term active participation. So there's an at least partial exception but we'll discuss that later. So we've got now if someone a real estate professional key term are they an active participant is going to be a key term that will come into play. So for a detailed discussion of these rules you can see publication 925 to dig into that in more detail. So we're looking at real estate professionals now so you got the real estate and now you're categorizing as a real estate professional. I mean if you are a real estate professional complete line 43 of schedule E so line 43 of schedule E that's basically schedule E page number 2. We're down here in part number 543 reconciliation for real estate professionals. If you were a real estate professional see instructions enter the net income or loss reported anywhere on form 1040 form 1040 SR or form 1040 NR from all rental real estate activities in which you materially participate under the passive activity rules. There's there's the line that we're looking at so you qualify as a real estate professional for the tax year if you meet both of the following requirements. This is going to be more stringent of requirement than basically actively participating right. So you've got someone who's completely passive to someone who actively participates to someone who's a real estate professional. And you would think that if someone was completely passive they would be most restrictive on being able to deduct their losses. If they are a real estate if they were actively participating they might get some some capability more capability. And then if they're a real estate professional you would think they have a larger capacity possibly to be deducting some of their losses. So more than half of the personal services you perform in all trade or businesses during the tax year are performed in real property trades or businesses in which you materially participate. You perform more than 750 hours of services during the tax year in real property trades or businesses in which you materially participate. So if you qualify as a real estate professional rental real estate activities in which you materially participate aren't passive activities. So now you can see that passive activity is removed so they're not passive anymore which means you should be released from some of the restrictions on the losses possibly being able to take those losses against other types of income because you're actively participating as a real estate professional and like W2 income for example. So for purposes of determining whether you materially participate in your rental real estate activities each interest in rental real estate is a separate activity unless you elect to treat all your interest in real estate as one activity. So in other words if I looked at my schedule E and I had multiple real estate activities here I'd have to determine for each one whether I was actively participating or not. And that will have an impact on whether or not the losses could be deduct deductible. You could see then the losses pulling over to to the page one eventually of the form 1040 in that instance or in that example at least. So for purposes of determining whether you materially participate in your rental real estate activities each interest in rental real estate is a separate activity unless you elect to treat all your interest in rental real estate as one activity. Don't count personal services you perform as an employee and real property trades or businesses unless you are a 5% owner of your employer. So if you're an employee then that's something different generally unless this exception applies then you know doing your own rental property that you would be reporting on the schedule E. So you are a 5% owner in your own or a or consider to own more than 5% of your employer's outstanding stock or capital or profit interest. So don't count your spouse's personal services to determine whether you meet the requirements listed earlier to qualify as a real estate professional. However, you can count your spouse's participation in an activity and determining if you materially participate real property trades or businesses. A real property trade or business is a trade or business that that does any of the following with real property develops or redevelops it constructs or reconstructs it acquires it converts its rents or lease it operates or manages it. So choice to treat all interest as one activity. So now if you have multiple real estate the option was to treat them all differently and apply this test to each one of them or do you do you treat them as one. So if you were a real estate professional and have more than one rental real estate interest during the year you can choose to treat all your interest as one activity. You can make this choice for any year that you qualify as a real estate professional. If you forego making the choice for one year you can still make it for a later year. If you make the choice it is binding for the tax year you make it and for any later year that you are a real estate professional. So once you make the choice then it becomes binding. So it looks like if you if you don't make the choice and you're then then you can continue with that you still have the option to make it. But once made then you're basically locked in it looks like is the general idea. So you want to consider that choice carefully. So this is true even if you aren't a real estate professional and enter in any intervening year for that year. The exception for real estate professionals won't apply and determine whether your activity is subject to the passive activity rules. See the instructions for Schedule E for information about making this choice. So if you want to you might want to do that check into it dive into it in a bit more detail because it's it could lock you in. So material participation generally you materially participate in an activity for the tax year. If you were involved in its operations on a regular continuously and substantial basis during the year for details you could see Publication 925 or the instructions for Schedule C participating spouse. So now you got the spouse involved because your joint in the in in in essence. So if you are married determine whether you materially participate in an activity by also counting any participation in the activity by your spouse during the year. Do this even if your spouse owns no interest in the activity or file files a separate return for the year for 8582. You may have to complete for 8582 to figure the amount of any passive activity loss for the current tax year for all activities and the amount of the passive activity loss allowed on your tax return. So here's a quick look at the form 8582 passive activity loss limitations passive activity loss limitations. Okay so then on your return C form 8582 not not required later in this chapter to determine if you must complete form 8582. If you are required to complete form 8582 and are also subject to the at risk rules include the amount for from form 6198 line 21 deductible loss in column B of form 8582 worksheet one or two as required. Exception for personal use of dwelling unit. If you use the rental property as a home during the year any income deductions gain or lost allocable to such use is not to be taken into account for purposes of the passive activity loss limitation. Instead follow the rules explained in chapter five.