 Income tax 2022-2023, reporting rental income, expenses and losses, limits on rental losses. Tax software example. Let's do some wealth preservation with some tax preparation. Here we are in our example. Form 1040 populated with LASERT tax software. You don't need tax software to follow along, but it's a great tool to run scenarios with. You can also get access to the Form 1040 related forms and schedules at the IRS website, irs.gov, irs.gov, starting point, single filer, Mr. Anderson, 90210 Beverly Hills, living in. We're going to start off with the W2 income and then think about if we have losses first with a Schedule C type of situation and then compare that to a Schedule E rental income type of situation. So we're starting with W2 income, 100,000, 12,950 standard deduction, 87,050 taxable income, page number two, calculating the tax at 14774. That is the total tax, no self-employment tax or anything like that with the W2 income. Back to page number one. So let's first think about a situation in which we had a loss with a Schedule C. Now remember, the general rule is that if you have income, obviously the IRS wants a piece of it, no big deal or nothing really unusual, but if you have a loss, then you could have certain situations where the loss could be limited. So if we have a loss, we would 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. I like to be able to take that loss against other income and we have more restrictions typically for those losses on a Schedule E versus a Schedule C. So let's start off with the Schedule C and then we'll go to the Schedule E to compare and contrast. So I'm going to say, all right, let's let's say we have a Schedule C here. We'll just put a generic Schedule C and let's pull that in and see what the difference is. If I go to the Schedule C then I'm going to say that we had 100,000 of income, 130,000 of expenses resulting in a 30,000 loss. We have a fairly significant loss here. So what's going to happen with that loss? If I if I pull it over to Schedule 1, we now have a loss for the business income here pulling in and that basically pulls into kind of like where normally the income line items are up top. We have this loss that's going to be pulling in with a negative kind of income item, which is great. It's basically taking kind of a deduction for the loss, pulling our 100,000 income from W2 income down to 70,000 bringing our taxable income after the standard deduction to 57,050, which of course has a very good positive impact on our tax. Now note with a with a normal loss the iris is going to be skeptical of these losses if for example they're questioning if it was a for business item or a hobby. So for example if you had race horses apparently there was a hobby of rich people with race horses for a while and they ran losses for for quite some time and the iris is saying hey that just looks like an expensive hobby rather than rather than an actual for profit business. But if it is a for profit business you would think it would be fair to take a loss at some point because of course the losses that you incur when you start a business are often necessary in order to generate the revenue in the future. So you would think that you would get some tax benefit for for the loss at some point. With the rental income we have more of the passive rules that are going to take place with it. So now let's see what happens what if I don't have any income to take against the loss. So let's let's say my my actual wages are zero I don't have any W2 let's just delete the whole thing. So now hold on a second we have this loss here of the 30,000 but there's no income to take against it. So obviously my my tax taxable income cannot go below zero because if it did that would result in a negative tax it result in the government paying us for the negative income the government doesn't want to be paying us they want to take a piece of our profits not be subject to our losses. So we might still get a benefit from that loss but it would have to be a carryover. So now we've got this NOL worksheet possibly being able to carry over the loss to a future time period. We can also see form 8995 qualified business income deduction simplified computation where we see down here we've got line 16 total qualified business loss carry forward and so on of the 30,000. So that means the IRS is saying I'm not going to pay you for the loss but you might still get a tax benefit possibly if you can match it out against income in the future. Okay we've got a similar kind of thing with the Schedule E but we might have some further limitations with the Schedule E. So let's start off with having income just from a Schedule E now so if we're a single filer and now we've got income rolling in from the Schedule E of 100,000 instead of the W2 income. So we've got Schedule E instead of the Schedule C and it's going to net out an income statement, nets out to the 100,000. Now generally because it's usually more of a passive activity we might not be subject to the self-employment tax which is a huge benefit but and then the IRS still wants their share of it because it's income. So that's going to pull into the 100,000 here and then it's going to pull into the form 1040. So there's the 100,000 now from the Schedule E 12,950 and 87,050. So pretty straightforward scenario if we have income in most cases because again the IRS is happy you made money and IRS wants a piece of it. So now let's imagine that we have a loss. So if we have a loss so now we've got an income statement in essence income minus expenses for the rental property resulting in a loss. So here's where the terms become very important for the ability to take the loss of are you a real estate professional? Are you actively participating or not right? So I'm going to say that we're not a real estate professional not actively participating first and therefore the passive law rules activity rules are basically kicking in not allowing the entire amount. Now if we actively participate we're going to get a piece of that generally but let's start out here and so we don't get any of that 30,000 and you can basically see that over on the form 8525 passive activity loss limits. So here's the 30,000 pulling in for the loss limit 30,000 that's pulling in here and that's the general idea. Now what's going to happen with that loss? We should be able to basically roll it over so that so that we get a benefit possibly in a following period but we would have to have a rental income in order to match up against the loss. So you can see a little cert basically saying here federal carryovers, unallowed passive losses. So now let's imagine that we step it up and we say that I'm not a real estate professional but I do actively participate and this is kind of like the default position oftentimes because oftentimes that's what you want to kind of shoot for if you're not a real estate professional you would like to be able to shoot for actively participating so that possibly when you have those losses you could take advantage of at least part of the losses. So this is kind of the in-between area so we're going to say we actively participate so now if I go back on over to the Schedule E same income statement there's the $30,000 loss but then we have the deductible rental real estate $25,000 so that's kind of the the maximum cap notice there's a $30,000 loss they won't give us all of it but they've given us the $25,000 if I look at my passive activity rules here passive activity rules then we've got the $30,000 up top and then special allowance for rental real estate activities with active participation so there's the $30,000 the phase out if it goes over $150,000 starts to phase that $25,000 down so if I'm over $150,000 of income then I'll lose that $25,000 but currently I have the $25,000 here so if I go through it we got $30,000 of the loss $5,000 has not been taken and you would think then the $5,000 would once again kind of roll forward to future years possibly being able to take in a future year if it's allowable at that time so now if I go back to the form 1040 you'll note that I have $25,000 that is allowable but I don't have any other income to take it against so now that's when the NOL basically kicks in so I've got a normal kind of NOL situation similar to the Schedule C situation because I don't have any other income to take it against if I had other income it would be similar to the Schedule C but limited to that $25,000 so the W-2 income here if that was $100,000 again now we're saying okay now I get to take that rental loss against possibly other income and remember a lot of times the rental property might run losses because people might be investing in the rental property to try to have the real estate property itself go up in value so it could be quite important to be able to take the losses so the plan would be we bought this house we're hoping it goes up in value just due to the location and that kind of stuff and if we have to run losses on the rental income then it is what it is we can if we could take the losses against other income that would be great right so if that is the strategy if there's a plan like that you can imagine that they're going to run losses they might not have rental income in future periods as opposed to a Schedule C type of business which is which obviously is a situation where you're where you're you need to have income for the for the for the business to continue in most cases so if you have a loss you would expect rental income and in future periods with the rental property you're probably you might be aiming for rental income but you know you're also hoping that the property value goes up and if you could take the losses against other income you know that would be good so you still want to have that income kind of goal but obviously there's this other factor that comes into play and being able to take the losses would be good and there's that limitation now that limitation as your income goes up will start to phase out so if I go up above 100,000 to like 115,000 it's going to start to phase out so if I go into the 1040 we can see what's pulling in here instead of 25,000 it's 17,5 and if we bring it up to the complete phase out over 150,000 then I no longer get the 25,000 so what we need to know when we're doing our planning is well I get to take the losses it's losses that are a problem if I have losses I would like to be able to take the losses if I'm actively participating I might be able to take losses up to 25,000 which is great but there's an income limit which starts to phase out at 100,000 and it's completely gone at 150,000 so and you would think that that would also don't like be higher for married filing joint but it's not so if I go to married filing joint we still have that same same limit here so we're not getting any any added benefit you would think that the limits would kind of double you know so so if I go back to 100,000 married filing joint 100,000 and pull it on over now we have the 25,000 and if I bring it up to 150 the software still saying you're losing the the 25,000 capacity to take to take that amount even married filing joint so it's a little bit weird but that is what it is so now let's go back I'm going to go back to single just to keep it keep it the same and then now let's say that that we actively participate I mean wait a sec I'm going to say we're a real estate professional real estate professional okay so then if I go back on over real estate professional it's pulling in the full 30,000 and again you can kind of think of the idea the thought process on this the IRS is saying hey we don't think rich like wealthy people taking massive losses on rental property that's passive we're going to wipe that out so they wipe it out and then people say hey wait a second I'm a real estate professional I should get a benefit like anybody else I'm not like a super wealthy person that's just having passive income this is my business so in that case you would think okay well they're going to allow the in that case or and then in the middle case well I'm not a I'm not a completely wealthy person perhaps I have I have real estate but I I actively participate in it it takes time and effort so I should get and that's the 25,000 middle point so then you want to make sure when you're when you're thinking about these categories whether you qualify most people would probably be shooting for the active participation unless of course they're real estate professional in which case you want to make sure that you qualify for the real estate professional now you also kind of want to be careful in terms of if you are like running something like a hotel or something like that whether or not you're going to be using a schedule E or a schedule C in that case all together is it should it be a schedule C type of business or a schedule E type of situation in that case and as we saw with the schedule C then you might be subject generally schedule C is going to be self-employment subject income that you'll have self-employment taxes that will have to be dealt with generally there all right so now I brought the income back down W to income 100,000 so we're not going to hit the threshold and then if I go into schedule E you can also imagine you have multiple properties now typically you're going to have a separate schedule E column at least if not other worksheet for each of the properties which will in essence be an income statement in and of itself so property A here we still have the $30,000 loss property B we're going to say we had a $10,000 gain and we're going to say that we actively participate in this case so in essence you're going to say okay well there's these two things will basically net out so now the gain was able to to absorb some of those losses to get us under the $25,000 threshold so if we net those out we're at $20,000 so the general idea here being that the passive income can offset passive losses whereas you're limited to be able to take the passive losses against other income such as W to income now we brought it down to 20,000 20,000 which was below the $25,000 threshold for the passive activities and and and we're under 100,000 AGI or 150,000 therefore we should be able to take the full amount we're under 100,000 and starts to phase out at 100 also note that if you're married and you both own the property you would think that you would have like the two taxpayers are now one entity for taxes but sometimes it can be a little bit more confusing than that usually that becomes more confusing with like a schedule C situation because you have to deal with the self-employment tax with the rental property you might not have that self-employment tax kind of situation you have to deal with but you have the same kind of concept in play in that you actually have two individuals which usually if you're not married would mean that you would need a partnership type of return unless you're going to be qualifying for like a qualified joint venture and if you're in a community property state sometimes the rules can change so you want to be aware of that might be able to basically choose instead of taxpayer we're going to have joint so so now it'll be joint between the two so for the schedule E but in any case in a in a married situation you want to take a look at the community community property rules for the state and think about whether you need a qualified joint venture what i mean about the self-employment tax is the idea that you notice that i'm not calculating any self-employment tax so the impact on the income oftentimes is going to be similar unless there's kind of like phase outs in terms of the allocation of income for other types of things from one spouse to the other in terms like of like investing into an IRA or something like that and allocating the income to the proper spouse in order to to deal with that otherwise you would think for a married couple it would result in you know similar federal income tax usually let's just take a look at a quick scenario with a schedule C so you can see what i'm talking about with the self-employment tax by contrast so now if i say we had schedule C income income 100 000 then that would mean we have to be dealing with the self-employment tax the self-employment tax calculation now if they were if there was a married couple then it's going to be important to calculate the self-employment tax per social security number not just because it might have an impact on the taxes overall but because it also will have an impact on the benefits from the social security so for example the tax here if i assign it to just one spouse the added tax for social security is that 8506 now if i say that they're joint i'm going to pretend they're like a community property state and i can just say joint so they split it you know down the middle type of thing that it gets a little bit messed up here because now it jumped up like whoa 14 130 and that's because we had this issue with a cap for the social security because of 100 000 of the income that's being assigned to one of the spouses but in essence this the self-employment tax is being split between the two of them which becomes important now if if they didn't have other income and they didn't hit the cap for the self-employment threshold let's take this w2 off here and delete that and say now they just have the schedule c income that's subject to the to the self-employment tax and then page 2 is at the 130 000 if i go back on over and i was to say just for one taxpayer we're still at the 14 129 it's basically the same if i but if i go into the schedule se then we only have it being assigned to uh the one spouse and not the other so if i was to say now i'm going to be joint then now we have the same total tax but now it's being split up between two forms one for one spouse and one for the other spouse so in this case because they're both under the threshold which does kind of mess things up the threshold is at 147 000 on a social security by social security so if you go over that the social security caps out so if you had other income or if this income goes over that if you had w2 income that can kind of skew things but if you're under that amount then you could see in this scenario we have both of those calculations ending with the same 14 130 may not have an impact on the federal income tax or the tax calculation at present but it can still be important because the money's going into the social security funds per social security number which will impact the benefits that people get at uh retirement which is going to be calculated on a per social security number type of basis