 Income tax 2022-2023 residential rental property, rental income and expenses if no personal use of dwelling, tax software example. Let's do some wealth preservation with some tax preparation. 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. 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.govirs.gov. So our starting point will be we've got the single file or Mr. Anderson living in 90210 Beverly Hills. And we're going to start off with the W2 income and then compare the same amount of income 100,000 from a W2 to a Schedule C to a Schedule E so our starting point W2 income 100,000. We've got the 12,950 that's the standard deduction that gets to the taxable income 87,050 page number two then calculating the tax at 14774 because this is W2 income. We don't have any self employment tax or any of that. So the tax remains at the 14774 now I'm just going to kind of jot that down over here on our little Excel worksheet. So we are first starting scenario. Let's make this a little bigger. Let's get rid of this row. Why is that there? That doesn't need to be there. Let's say this was 100,000 and the AGI was 100,000. The taxable income was 8750, 8750 the federal tax then page number two 14774 14774 self employment tax zero total tax 14774. Let's compare that then to a Schedule C income and then we'll go to a Schedule E income. So it gets a lot more complicated when I get to a Schedule C although the idea of what's deductible when you get to a Schedule C and a Schedule E makes more sense because when we just have the W2 income oftentimes the things that might be deductible for example if we go to a Schedule A are things that aren't like natural to an income tax system. You would expect the things that would be natural to an income tax system would be to be able to deduct those expenses needed in order to generate the income so that you tax people on net income not on the gross income. But with W2 income it's the idea would be that the employer took care of all those business related items so the income doesn't have anything that you needed to expand in order to generate the income and therefore the things that we think about as deductions are kind of unnatural like medical expenses, taxes, interest on your personal residence and that kind of you know charitable gifts. These are things that have other reasons other than being a natural thing for income taxes to be able to deduct. When we get to the Schedule C and the Schedule E we have a standard income statement which at least from that point just the income statement makes perfect sense you would think from an income tax type of system because we have income and then the expenses that we needed to expand in order to generate the income those are the deductible amounts for those items. Alright let's go back on over and I'm going to say let's get rid of the W2 income. That's no more and let's add a Schedule C. Okay this adds a lot of a mess to it and I did just a generic Schedule C and so if I go to the Schedule C this is the profit or loss from a business and then we'll go to a Schedule E you'll note I put a little income statement so we have 120,000 of income we have the 20,000 of expenses so we get to that 100,000 which is mirroring a similar kind of thing with the W2 income where we have the 100,000 straight from the W2 income. Now that 100,000 is going to flow into Schedule 1 so there's the 100,000 here it's going to flow into the form 1040 not on line 1A but rather on line 8 here so we got the 100,000 but then we got some other stuff happening one of which being on page 2 we're not just calculating the federal income tax but now we have the self-employment tax so this becomes a big deal because that could be quite significant the self-employment tax so if I then go on over and say okay how was that calculated well we have the Schedule C and the net income on the Schedule C flowed into the Schedule SE self-employment tax we calculated then the 14129 which flowed into page 2 there's the 14129 which is flowed into the form 1040 page 2 and there's the 14129 that's quite significant and then we get half of that is actually deductible so now we also have on page 1 this item that got populated in the adjustments to income how was that how did that happen well we've got the Schedule C where we've got the 100,000 that is flowing into the Schedule SE and that's going to be the 14129 self-employment tax which is similar to like payroll taxes if we were but we would it'd be like the employee employee or portion payroll taxes then we've got half of it 7065 that's what's flowing into Schedule 1 page number 2 there's that that's what's flowing into the form 1040 so now we've got the 100,000 income the 7065 so we have an adjusted gross income that is now 92,935 we've got the same standard deduction 12,950 but then we also have this qualified business income deduction which you know that came came into play a few years ago and obviously is quite significant here so that muddies up the water and so we've got the 15994 huge item there and then that gets our taxable income to the 63,988 page number 2 then the taxable income is a lot lower than it was with the with the W2 income so the federal income tax is much lower 9,692 but we've got this giant self-employment tax which is more than what you would pay on on a W2 employee situation because you would only pay the employee portion not the employer portion so it's kind of like doubled you know what you would you would be doing if you were made the 100,000 as a employee not quite double but close and so that gives us a tax of 23821 so let's check that out so I'm gonna let's jot that down jot it down jot it down so we're gonna say we had 100,000 this time of Schedule C income but the AGI is only 92,935 so 92935 did I get that right did I get that right people yes thank you and 12,000 so that means the 63,988 63,988 is here federal income tax on page number 2 is only 9,692 9,692 self-employment tax though now is in play 14129 14129 and then the total tax is now 23821 23821 so the bottom line is the Schedule C is working out worse for us even though the federal income tax is less because we've got this massive we've got this massive self-employment tax which you might say well hey the W2 income paid the self-employment tax as well and the withholdings and they did they paid half of the self-employment tax though whereas this is twice the you know we had to pay more self-employment tax here like double the self-employment so it gets quite kind of messy and confusing as to which which one of those is going to play out best but one of the factors that are coming into play here of course is you know the self-employment tax is a big issue now when we get to the Schedule E because the Schedule E oftentimes is more of a passive income then we might move from reporting it on the Schedule C and the Schedule C is usually the form that you're going to use in an active type of business because that's going to generate and calculate the self-employment tax if we have a rental property that's more of a passive property then the idea hopefully it's not subject to the self-employment tax would be nice so let's now let's now get rid of the Schedule C and say let's remove the Schedule C let's just delete it and then now let's do a similar kind of thing on it on just a kind of a standard Schedule E and we can get more into like the details of the Schedule E but I'll just do a similar kind of general scenario on the Schedule E I have now replaced the Schedule C with a Schedule E supplemental income and laws from rental real estate royalties partnership and so on and so forth we might go into more detail up top here but for now note that down here we have a normal kind of income statement format similar to what we saw on the Schedule C income minus expenses those ordinary and necessary expenses we needed to generate the income gets down to the net income of the 100,000 again that's going to pull into the Schedule 1 so it's pulling into the Schedule 1 which is pulling into the form 1040 the form 1040 here there's the 100,000 however there's a lot less action going on this looks a lot more similar to what we saw with the W-2 type of income because then we have to we just have the 12,950 of the standard deduction gets us to the 87,050 page number two calculating the tax at the 14774 and we don't have that self-employment tax all that kind of scenario that was taking place so this is basically mirroring similar to what we had with the W-2 kind of situation although it's pulling in from a Schedule C this was 100,000 100,000 so the AGI 100,000 and this is 87,050 and the federal income tax on page number two then is 14774 14774 no self-employment tax generally so that's the general idea and then we're going to say 14774 so you can see that the Schedule C is it could actually be a lot more a lot more confusing it's actually a lot more confusing for me or have a lot more impacts because it's often going to be subject to that self-employment tax although the Schedule E can get kind of confusing especially when you get into the range of losses and you typically have to deal with other things that are confusing on a Schedule E including things like depreciation of the property as well as when people get into more complex Schedule C areas where you don't have just a pure rental property but they have like their home and they're renting part of it or something like that where it's a co-mingling of business and personal or if they have a vacation home and they're renting it so those kind of things become confusing factors with the rental property let's now focus on Schedule E in more detail we have part number one income or loss from rental real estate and royalties note if you are in the business of renting personal property use Schedule C because in that case it would be business income Schedule C then being subject to the self-employment tax see instructions if you are an individual report form rental income or loss from form 4835 on page two line 40 then we have the question of did you make any payments in 2022 that would require you to file form 1099 in other words did you have contractors and stuff that you paid and you have to issue them the 1099s if yes did you or will you file the required forms so we're going to assume yes you filed the 1099 forms as required for the contractor work physical address of each property so we've got the address of the property type of the property so here's the number reference to types of property down below single family residence multi-family residence vacation short-term rental commercial land royalties self-rental and other so for each rental real estate property listed above report the number of fair rental and personal use days check the QJV box only if you meet the requirements to file a qualified joint venture so we're going to assume here the 365 days things get a little bit more messy when there's personal use days often the case when you have like a vacation home kind of scenario in place and then of course down below we've got the standard income statement a little bit different than the look of the schedule c because it's possible to have multiple properties on the on this one form right so we've got a b and c on the properties obviously the rents received would be like the normal income line instead of just general income on the schedule c because it's a rental property so that would be pretty much uniform you would expect if you had rental properties and then the expenses that you had to consume in order to generate those similar concepts with the schedule c ordinary and necessary expenses advertising auto travel cleaning commission insurance legal management fees repairs supplies taxes utilities depreciation other the general format of types of expenses and then in essence we're going to be adding these up and getting down to the net income although it gets a little bit messy down here because when we get into a loss scenario in particular we could be limited due to passive passive activity rules which we'll talk more about in future presentations but the general idea is that you've got to be the iris is skeptical on the rental property because of losses now the other big expense here is depreciation which will will dive into it in a in a future presentation and focus on the depreciation because the cost of the property itself is going to be a huge cost and we have to allocate that cost over a fairly long time frame based on what the tax code is requiring us to do we also have the other big one of course is the mortgage interest which you're most likely familiar with as something that could be deductible on the schedule a if the mortgage interest was for your personal residence but now we're talking about a rental property which you've got a similar kind of loan from the bank for that has the property as collateral but now it's not personal property it's not your personal residence you needed that for to purchase the home and so now you're paying the expense on the purchasing power the rent on the purchasing power which is going to be the interest that's going to be another kind of big factor here now when we get into these losses i just want to kind of point out that the difference here because if you look at a schedule c kind of income if i was doing some kind of business now it's just earning money on a schedule c i did some gig work or whatever i'm doing on in the platforms paying me youtube is paying me or whatever is happening then then then i would have income minus my expenses here and that would be the main the main thing i would be doing my job for but the schedule e can be a little bit different because if i buy this property there's a couple things i'm looking for from this property one is of course to generate revenue so i'm going to i'm going to want to generate revenue by renting out the property if i bought it as a rental property and i'm going to have to have revenue for a significant amount of time in order to recoup of course the cost of the property but the other factor is that that this is not like a piece of equipment that i bought for my schedule c business because most stuff that's depreciable property will deteriorate in value if i bought a forklift if i bought a machine that i needed to use in my business it's going to depreciate down in value so although the property itself will depreciate it'll have wear and tear to it and will record depreciation it's quite possible and what i'm probably hoping for is just due to the location if if nothing else the the value of the property actually increases and that's what's kind of difference about real estate because we have an investment in the value of the property which is probably a significant part of the purchase of the real estate in addition to just the income that you're getting down here so what the iris is is going to be skeptical of is people buying property in order to of course just kind of sit on it and hope that it appreciates you know in value while renting it out a little bit possibly but running losses even if you run significant losses on the rentals here because you can then take the losses against your other income so in that case you would you'd be running losses you'd get a benefit from the losses that you can take against other income and your primary hope is that the that the property actually increases in value just due to the location of the property or something like that so you can see the dynamic is a little bit a little bit different than like a service business on a schedule c because you don't have that factor of you thinking that you're that the value of your youtube channel or whatever is going to explode or something it's really you're just working to generate revenue in the short term is the general idea so that kind of muddies up the picture in terms of okay what what happens with the passive activity rule so the iris is even a little bit more skeptical than on a schedule c business when you get into the losses and and questioning as to whether you should be able to take those losses against like other income and so that that gets into these you know passive activity rules we'll talk about more if you have income then it's not really an issue if you have rental income then obviously the iris wants their share if you have losses the iris is going to be skeptical now many of these other expenses are going to be pretty much similar to what you saw with the schedule c so you've got to think about your accounting method oftentimes the method is going to be a cash based method for a lot of people that are doing the rental property because it's kind of easier and we don't have a lot of the things that forces to go to the accrual method such as tracking inventory that's what usually pushes people on a schedule c business from being able to use a cash based method to having to use an accrual method because the inventory kind of pushes people over when we get to things like auto expenses for example then you've got a similar kind of question there and how you're going to do that is it going to be the mileage method or you're going to do the direct write-off method there's you know you have to travel uh that that similar rules with a with a schedule c type of business with those types of items the big difference is being the the mortgage interest is clearly going to be almost always a component of the rental property and the depreciation is going to be a clear component of the rental property now the other big thing that comes up with the rental property that might be a little bit different than what comes up with a schedule c oftentimes is that you're going to end up with repairs right so the rental property needs to be repaired and then there's always the question comes up then well if I have a big number in this repair item is it something that is a repair or is it something that is actually I need to capitalize as a depreciable item and you can see the difference here if I had if I spent $15,000 on the roof then the question is do I get that $15,000 as an expense which I would like to do because if I can expense it at $15,000 then I would reduce my income in this period and I'd get the the benefit now or do I have to put it on there as like an improvement in which case I would have to amortize or depreciate the improvement over a long period of time I wouldn't get the I would still get the benefit but it would take a lot longer I would like to get the benefit sooner due to the time value of money so you get this always this question of I and in the quit the idea from arts perspective I would like to format things in such a ways that I don't have to capitalize them if I can and rather take the expense at the point in time I put them on the books so I could maximize the expense here and if I have to put it on the books as a as an asset and and then depreciate is there any way I can I can break it down so I have a lesser time frame to depreciate over in other words if I have to put it on the books as an asset and I fixed the roof is it possible that I could basically say well instead of making it you know 15-year property or 30-year improvement or something like that could I say well part of it was for air conditioning or something and the air conditioning should be equipment which is depreciated over seven years instead of you know those kind of questions often can come up and when you're when you're working on the rental property and you're allocating the expenses whenever you look at this repairs and maintenance kind of category you often want to scan that and say okay are there any huge items in here that look like they are may not be repairs but rather be some kind of improvements and when we're thinking about making big repairs and improvements we want to think about the depreciation schedules do I have how am I going to put this on the books with regards to depreciation because I can have a significant tax impact