In most cases, the taxpayer must report all rental income on his or her tax return. Generally, Schedule E (Form 1040) is used to report rental real estate income and expenses. If a taxpayer has a loss from rental real estate, he or she may have to reduce his or her loss or may not be allowed. The cash or fair market value of the property or services you receive for the use of the real or personal property is taxable to you as rental income.
In general, you can deduct rental property expenses from your rental income. The IRS may discover unreported rental income through tax audits. The purpose of an IRS tax audit is to review and examine an individual's financial information and accounts to confirm that income was reported correctly. An audit can be triggered through random selection, computer screening and related taxpayers.
Once you are selected for a tax audit, you will be contacted by mail to begin the process of reviewing your records. If you earn income through self-employment or rental income, a red flag may be embedded in your return. Unlike wage earners, sole proprietors or landlords may report income and expenses at their discretion, especially in cases where individuals receive cash or unreported payments from clients or customers. The IRS may impose penalties on landlords who fail to report rental income.
If the underreporting is a legitimate error, the IRS will collect its underpayment penalty, which accrues at a rate of 0.05 percent per month up to a maximum of 25 percent of the total tax due. However, if a homeowner intentionally omits income on their return, the IRS will collect their fraudulent filing penalty, which can include 20 percent of the unpaid amount along with a penalty of 75 percent of the total tax due. These penalties are in addition to the taxes still owed. A property that you own and rent to tenants for 15 days or more each year is considered rental property by the Internal Revenue Service.
The IRS defines rental property as a single-family home, flat, condominium, mobile home, holiday home or similar dwelling. Owning real estate carries with it tax responsibilities. In fact, if you own rental property, you will find that you have additional tax duties. Specifically, the IRS requires you to report all rental income on your tax return, as well as associated expenses.
The program matches income reported on federal income tax returns with information obtained from third parties, such as employers and financial institutions. In fact, H&R Block Online and H&R Block Premium Tax Software can help you manage your rental income tax filing requirements as well as the rest of your tax return. To make things a little easier, the IRS and others publish percentage tables that can be applied to the original cost to determine annual depreciation. For information on repairs and improvements, and depreciation of most rental property, see Publication 527, Residential Rental Property (Including Rental of Vacation Homes).
While normal maintenance counts, if you decide to make your rental property much fancier, or convert a one-bedroom unit into a two-bedroom unit, you cannot deduct those types of discretionary expenses. In many cases, the IRS wants to deal directly with the taxpayer, as taxpayer representatives often delay the process. Tax Form 8582, Passive Activity Loss Limitations, Form 6198, Risk Limitations, and Publication 527, Residential Rental Property, provide more information on the limited loss. However, there are some unique cases where the IRS does not expect you to report your rental income.
However, if you mix business with pleasure, you are required to allocate travel expenses between deductible business expenses and nondeductible personal expenses. Owning rental property has many advantages, and the tax deductions and benefits you receive are considered one of the biggest. After determining the cost or other tax basis of the rental property as a whole, you must allocate the amount of basis among the different types of property you are renting. While his real estate business runs on autopilot, he writes articles to help other investors grow and manage their real estate portfolios.
If you are curious about how to add rental income to your tax return, there is tax software for rental income.