 Income tax 2021-2022 residential rental property rental income and expenses if no personal use of dwelling 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 on the irs website irs.gov irs.gov looking at the income tax formula line one income we would typically have another schedule basically an income statement with income and expenses expenses basically being deductions the net then is what rolls into line one income here on the income tax formula and eventually onto the first page of the form 1040 this is the schedule e basically the income tape statement type of schedule the supplemental income and laws were focused on the rental real estate so we're continuing on to other sources of rental income lease with option to buy this might be a less common type of lease structure but when we're putting together leases we can imagine putting them together in imaginative ways and many different types of ways some of those ways run into kind of substance versus structure types of problems in other words we could end up in a situation where you can imagine something being set up as basically a lease in the structure of it but the substance of it actually looks more like a purchase type of situation obviously those get a little bit more complex when you get into those kinds of issues so in this case we have a lease with an option to buy if the rental agreement gives the tenant the right to buy your rental property the payments you receive under the agreement are generally rental income so we're still going to be putting them as the rental income if your tenant exercises the right to buy the property the payments you receive for the period after the date of the sale are considered part of the selling price so obviously some of the issue here would be then if there's an option to buy we have income clearly that's that's happening but how are we categorizing that income is it part of the purchase price or is it part of the of the rental income which is tough to say if the exercising of the option to buy hasn't been made but you're still receiving the payments for the property so part interest if you own a part interest and rental property you must report your part of the rental income from the property so you can imagine of course situations where you have a part of an interest in the rental property and of course in that situation you would have to report your part of the interest a rental of property also used as your home so now we have a little bit more complicated situation because if it's your home then you're renting part of your home and now you have like your principal residence which has its own tax complications and what not possibly being able to deduct mortgage and property taxes for example and part of it then possibly being a rental of the home which then you want to apply the rental kind of rules for it which might include like depreciation which becomes more complicated given the fact that only part of the home the property is being rented and so on so if you rent property that you also use as your home and you rent it less than 15 days during the tax year don't include the rent you receive in your income so we've got that low day threshold if it was only 15 days pretty low threshold then you can you can exclude it possibly so also expenses from this activity are not considered rental expenses so clearly if they don't make you record the income then they're not going to allow you to deduct the expenses most likely so for more information you could see used as a home but rented less than 50 days under reporting income and deductions in chapter number five rental expenses and most cases the expenses of renting your property such as maintenance insurance taxes interest can be deducted from your rental income this is just like normal like what you would expect from an income tax and what you see quite clearly generally in business type of activities such as a schedule see the types of things that you can deduct are those things that you used in order to generate the revenue which is what you would expect from an income tax because an income tax you would think shouldn't be applied on the gross income it should be applied on the net income otherwise it would be favoring certain types of businesses that don't have large you know capital investments that need to be put in place which are the more risky businesses we don't want to discourage you know that kind of investment so on so here we go personal use of the rental property if you if you sometimes use your rental property for personal purposes you must divide your expenses between rental and personal use now this is just like anything else once we start to commingle the business and personal it gets confusing for most businesses we would like to not do that we would like to have them separate but when we talk about real estate property it's quite possible that we use part of it for rental and part of it for personal in some way or another if that's the case then the expenses we're going to have to figure out how to allocate the expenses to the rental versus the personal because the personal may not be able to be deducted whereas the rental may be able to be deducted also your rental expenses deduction may be limited you can see chapter five for more information there part interest if you own a part interest in rental property you can deduct expenses you paid according to your percentage of ownership so obviously there when you got the expenses you would typically be thinking well now we're going to figure the rental income minus the expenses and then possibly divide out the net then to the owners meaning the owners had to recognize the income and they got the percentage of the allocation of the expenses to the rental property as well would be the general idea note that on the income side of things you don't have this kind of allocation problem generally because obviously if you only rented you know part that you know only part of the property was rented or part of a year was the property was rented then the rental income you got wasn't allocated for the whole property usually the rental income was for the part of the year that you rented the property so you don't have that kind of allocation method as much with the income generally you have it with the expenses because the expenses that you're paying are going to be for both personal and business uses typically and that's where the allocation typically comes into play so example roger owns a one half undivided interest in a rental house last year he paid nine sixty eight for necessary repairs on the property roger can deduct four hundred and eighty four which is fifty percent of the nine sixty eight as rental expenses so he is entitled to a reimbursement for the remaining half of the co-owner of to the co-owner so one more time roger owns exactly one half one half undivided interest in a rental interest so last year he paid nine sixty eight for necessary repairs on the property roger can deduct four eighty four which of course is the fifty percent of it okay when to deduct you generally deduct your rental expenses in the year you pay them because usually we're thinking cash method here so in the year that you paid it if you use the accrual method however then you want to see publication five three eight for more information so that you got the accrual method the accrual method is oftentimes more accurate from an accounting standpoint but the iris will often limit things on the on the accrual method or you know you might have adjustments on the accrual method when you saw as we saw for like prepayments of rent and so on and so forth so types of expenses listed below are the most common rental expenses so you're probably going to have like advertising if you're advertising the rental auto and travel expenses auto and travel are always kind of a little bit confusing with regards to any type of business we have because we've got to think about how we're going to allocate that we could have a business and personal component to them as well so we might dive into that in a little bit more cleaning and maintenance commissions depreciation and insurance interest legal and other professional fees local transportation expenses management fees mortgage interest paid to banks etc notice that the mortgage interest isn't going to be deducted on schedule a every anytime you hear mortgage interest you're probably thinking no that's on schedule a no we're talking this is the rental property not your personal residence in general unless you're doing personal residence residence and renting part of it in which case you might be allocating it between the the schedule e rental property possibly and schedule a in that case points and the same kind issue rental payments repairs taxes utilities and so on and so forth so depreciation what is that that's going to be a key component confusing component that we got to take into consideration so depreciation is a capital expense it is the mechanism for recovering your cost in and income producing property and must be taken over the expected life of the property so when you buy the property even if you were to have paid full cash for the rental property and using it totally for rental property you got to adhere to the depreciation rules which means you wouldn't generally just expense it even if you're on a cash basis when you bought it even if you paid full cash for it you got to put it on the books as basically an asset if you're doing a a if you're reporting this on a schedule e on your personal income taxes then you're not going to have a balance sheet you only have the schedule e which is in essence an income statement but you will have a depreciation schedule that you'll have to be tracking which will basically be that part of the balance sheet show you that asset and the depreciation related to that which is basically going to be allocating the cost over the life that whatever life the tax code allows you to depreciate it over so you can begin to depreciate rental property when it is ready and available for rent see place in service under when does depreciation begin and end in chapter two insurance premium is paid in advance if you paid an insurance premium for the for more than one year in advance you can't deduct the total premium in the year you paid it so this is a common thing with advanced payments we're we're assuming we're like we're on let's say we're on the cash basis here so we get to deduct things when we pay them then you might start thinking well i'll just prepay a lot of stuff in the current year to lower my current income and that's how you'll manipulate things on a cash basis for example paying five years worth of insurance in this year well you can't do that because the iris is going to say i'm not going to allow you to do that that's what they say because they don't want people manipulating the cash basis by manipulating the cash flow to adjust their income to egregiously so for each year of coverage you can deduct only the part of a premium payment that applies to that year c chapter six of publication five three five for information on deduction deductible premiums interest expense you can deduct mortgage interest you pay on your rental property so again we're not talking about the home we're not talking about your principal residence we're not talking about deducting it on the schedule a itemized deductions here we're talking about the rental property possibly deducting it then on schedule e now you might have a home that you rent part of it in which case you might have to do that allocation thing we might get some deduction on the schedule e some deduction on the schedule a but we're thinking here the rental component that's what we're that's what we're talking about when you reference rental property for more than the previous outstanding balance the portion of the interest allocable to the loan proceeds not related to rental use generally can't be deducted as rental expenses once again when you reference a rental property for more than the previous outstanding balance the portion of interest allocated to loan proceeds not related to rental use generally can't be deducted on the rental expense so chapter four publication five three five explains mortgage interest in more detail if you want to check that out expenses paid to obtain a mortgage certain expenses made you may pay to obtain a mortgage on your rental property can't be deducted as interest these expenses which include mortgage commission abstract fees and recording fees are capital expenses that are part of your basis in the property so note when you're talking about like this mortgage interest on if it was your principal residence which is a personal property which wouldn't normally be deductible unless there's a special rule which there is for for your personal residence to deduct the mortgage interest you've got this kind of issue you might be aware of with with points and whatnot and determining what is interest or not but you don't often get to deduct things for for the home at you know on the schedule a that are basically the abstract and the recording fees and so on so now we're talking about the rental property we have the same kind of issue where we're saying okay you can't really deduct as interest these things that that were that were included expenses paid to obtain the more obtain a mortgage but we're going to instead call them part of basically the purchase price so that means that we can get a benefit from it by basically increasing the basis and then when we sell the property we get a benefit so it's not as great a benefit then or we get a benefit when we when we depreciate the property that means we're not getting the benefit you know upfront but we've got it we've got to capitalize it and then either take that benefit over the depreciation of the property when we allocate the costs over some useful life that the that the that the tax code allows us and of course then if we were to sell the property we would have a higher basis which would be beneficial for the sale because that would lower the amount of possible gains okay so we got form 1098 mortgage interest statement if you paid $600 or more of mortgage interest on your rental property to any one person you should receive a form 1098 or similar statement showing the interest you paid for the year so we got that that form that's going to help us out of course to record the information notice that if we have you know multiple rental properties and personal property and so on we got to make sure that we get the 1098s straight is this personal property is this my home is this rental property 1098 whatnot and the tax preparers got to know what's what and where's where's they know what's what and where to put the what to which form like a schedule a or schedule e and whatnot so if you if you at least one other person other than your spouse if you file a joint return reliable for and paid interest on the mortgage and the other person received the form 1098 report your share of the interest on schedule e form 1040 so hopefully the 1098 goes to goes to the you know the person that's going to be reporting the expense but you could have you can imagine complications words you know the 1098 is going somewhere so attach a statement to your return showing the name and address of the other person so obviously if the 1098 wasn't issued to you that 1099 1098 did not only go to you it went to the IRS so so that will cause some skepticism on the IRS side so you want to make sure that you make them aware of that so legal and other professional fees you can deduct as rental expense legal and other professional expenses such as tax return preparation fees you pay to prepare your schedule e part one so this is something obviously if you have a tax preparer doing the taxes then they're doing possibly all your taxes including the schedule e you don't get these days a deduction you know elsewhere typically for the tax preparation so whatever portion of that expense is being allocated to the taxes or for the schedule e then possibly you want to deduct that on the schedule e so for example on your 2021 schedule e you can deduct the fees paid in 2021 to prepare part one of schedule 2020 schedule e you can also deduct as rental expense any expense other than federal taxes and penalties you're paid to resolve a tax underpayment uh related to your rental activities local benefit taxes in most cases you can't deduct the charges for local benefits that increase the value of your property such as charges for putting in streets sidewalks or other water and sewer systems these charges are non depreciable capital expenditures and must be added to the basis of your property so once again they they sound more like improvements possibly at that point so you don't really so you might have to put them on the books as an asset depreciate them which you still get a benefit from but you don't get the benefit up front per se but have to allocate it over the useful life taking it in the form of depreciation or possibly uh getting the benefit in an increased basis when you sell the property lowering the gain at that point in time which would be the tax benefit so however you can deduct local benefit taxes that are for maintaining repairing or paying interest charges for the benefits so you've got this issue as to whether something is you know repairing a situation or like an improving type of situation and if it's a repair even if it's a fairly expensive one then you get categorized it possibly as an expense getting the deduction now which is typically better as opposed to if it's like an improvement or something like that or something you would need to capitalize so that becomes kind of a tricky type of issue and so whatever you're doing a large kind of expenditure whether you want to look at that distinction is it repairs is it is it do I have to capitalize it what are the rules related to this particular thing that I'm doing and what are they going to be the tax implications of it because it might be a high dollar amount activity so local transportation expenses you may be able to deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage conserve or maintain your rental property however transportation expenses incurred to travel between your home and rental property generally constitute non deductible commuting costs unless you use your home as your principal place of business so we always got to take into consideration this whole commuting thing when we're calculating is it a commute or or or or not and one of the things we got to we got to put into consideration is the principal place of business to help with that consideration so as you could see publication 587 business use of home for information on determining if your home uh home office qualifies as a principal place of business so generally if you use your personal car pickup truck or light van for rental activities you can deduct the expenses using one of two methods you got the accrual expenses or the standard mileage rate so the actual expenses not the accrual expenses the actual expenses or the standard mileage rate so many people are familiar with this it does have an impact on your bookkeeping if you were to use the standard mileage rate for example then you're going to use a rate you got to count your miles it's easier but then when you have your bookkeeping obviously all your car related expenses gas and whatnot are are going to be now calculated differently on the taxes and it becomes a kind of a kind of a little bit confusing so we might dive into that we looked at we looked at that on the schedule see stuff but that's that same kind of issue here for 2021 the standard mileage rate for business use is 56 cents a mile for more information you can see chapter 4 publication 463 you find that on the irs website pre rental expenses you can deduct your ordinary and necessary expenses for managing conserving and maintaining rental property from the time you make it available for rent rental of equipment you can deduct the rent you pay for equipment that you use for the rental purpose however in some cases lease contracts are actually purchase contracts if so you don't deduct these payments so we got the same kind of issue with the with the lease payments if they're capital kind of things that we're using and in the rental property the question is structure versus form question is the thing set up as a lease but actually in form is a purchase and and then we have to basically treat it accordingly depending on our determination so you can recover the cost of purchase equipment through depreciation so if we purchase the large piece of equipment then we got it we got to put it on the books as an asset similar to the rental property itself and then depreciate it according to the tax code that's why sometimes people if there was incentives for people to try to set something up as a lease instead of as a purchase even though the lease looks a lot like a purchase which would be like a capital lease in which case you might still have to put it on the books as as in essence a purchase in that case so rental of property you can deduct the rent you pay for property that you use for rental purposes if you buy or if you buy a lease hold for rental purposes you can deduct an equal part of the cost each year over the term of the lease travel expenses you can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip is to collect rental income or to manage conserve or maintain your rental property you must prop you must properly allocate your expenses between rental and non-rental activities so obviously the travel expenses get a little bit confusing because you you got traveling and you might be doing some personal stuff on the travel and then the business stuff and then you got to be allocating between the business and personal you can't deduct the cost of traveling away from home if the primary purpose of the trip is to improve is to improve the price you can't deduct the cost of traveling away from home if the primary purpose of the trip is to improve the property the cost of improvements is recovered by taking depreciation so if you're traveling as for an improvement purposes to improve the property you got that same kind of issue as to whether something should be expensed in the current period or is it an improvement if it's categorized as an improvement you got to record it basically as an asset again capitalizing it in essence and you'd still get the benefit but you wouldn't get it upfront like you'd like to get it in the current year most likely you you're going to have to then take it in the form of depreciation over the some life that the tax code is going to allow you to take it over and or at the point in time you sell the property because you'll have a higher basis in it lowering the gain and lowering therefore the tax related to it so for information on travel expenses you could see chapter one publication 463 for more detail uncollected rent if you are a cash basis taxpayer don't deduct uncollected rent because you haven't included it in your income it's not deductible so obviously if it's uncollected rent and you're basically on a cash basis type of system then you haven't included it in cash because it's you haven't gotten it at that point now if you're on an accrual basis method then it might be a different system because you might have recorded the revenue at the point in time you earned it because they they use the property but if you're under a cash basis system then obviously if they haven't collected the rent you haven't included it in income so you're not going to deduct it as an expense if you use an accrual method report income when you earn it if you are unable to collect the rent you may be able to deduct a business bad debt so if you're on the accrual method then you're going to record the income when it's been earned meaning when the rental when the renters rented the property or consumed the use of the property for like a month or whatever and then if they don't pay you the money then at some point in the future you're going to determine that that money is uncollectible and at that point that's when you might be able to expense it possibly in the form of bad debt so you can see chapter 10 publication 535 for more information about business bad debts vacant rental property so now you got an empty rental property if you hold property for rental purposes you may be able to deduct your ordinary and necessary expenses including depreciation for managing conserving or maintaining the property while the property is vacant so no one's in it it's still it's still rental property i just can't rent it it's still rental property however you can't deduct any loss of rental income for the period the property is vacant so again the iris is skeptical about taking losses right if you're not actively renting the property then they're going to be skeptical of the losses and and again a lot of people that when they buy the rental property that you you're actually looking for long-term growth or increase in the value of the property so you might just have have it be vacant try to call it rental property so you could deduct the losses on the rental property which would be beneficial for taxes and hope that the property increases in in value and so if that was the case you know that that would be more like an investment it's not really an active rental type of property it's a passive kind of investment kind of thing in that instance so anytime there's a loss kind of situation iris is going to be skeptical of it and so you got to look into that make sure you've got the bases are covered on that one got someone on all the bases so you've got like a like the bases are loaded so vacant while listed for sale so if you sell property you help for rental purposes you can deduct the ordinary and necessary expenses for managing conserving or maintaining the property until it is sold if the property isn't held out and available for rent while listed for sale the expenses aren't deductible rental expenses so again if it's a rental property you would think you would be in the act of trying to rent it and if not then you know the iris is going to question whether or not it's actually you know rental property