Property rented for less than fifteen days. Any time you leased your property for less than fifteen days total in the past year, you don’t have to file any of your rental revenue. If this is the scenario, then the real estate property is going to be considered personal for taxation considerations, and on Schedule A of Form 1040, it is possible to deduct any of the property associated expenditures as personal.

Employing Your Holiday Home as a Part Time Rental

Personal use test. It’s important to work with some type of numeric formula to determine the total number of days during which the rental property was used for personal use. That is the personal use test. How you deduct your rental expenses is going to largely be determined by whether or not the personal use test is satisfied. Finding out the actual quantity of days in the past year in which the real estate property was leased out at fair market value is the initial step in calculating the personal use test. The next step is to multiply that number of days by ten percent. We will label the outcome the “total days rented” or “TDR” for short. The next stage will be to figure out how many days the rental property was employed for private use. We can label this “personal use days” or “PUD” abbreviated. Look at the table below for a vision of the personal use test.

NOTE: “Personal use” consists of use by you, any other owners of the home and property, plus the families of all individuals who own the property, unless of course your family member is paying out rent at fair market value.

If test is satisfied. If the personal use test is satisfied, you will deduct your rental expenses only to the extent of the rental income. A net rental loss will not be attainable, but when there are any additional expenditures you do not write off this year, they can be moved forward to later years, provided that there is an adequate sum of rental earnings in the tax year in which you claim them.

If test is not satisfied. Your own leasing costs will never be restricted by the rental income if the personal use test is not satisfied. You could deduct your rental costs and also have a net rental loss. There could be a few passive activity rules, however, which may still restrict the rental loss tax deduction.

Computing all of your rental expenditures. A number of expenses should be allocated between leasing and personal application. These include expenditures that will have already been charged no matter the use, such as real estate taxes and mortgage interest. Find out the whole number of personal use days. Then, you will need to determine the total quantity of TDR. After that, divide rental days by the sum of PUD and rental days. The end result is the rental percentage. Finally, you have to multiply the total cost of your expenses by the leasing percentage that you have established, and then the result will be the rental deductible part.

Leasing a Section of Your House

You need to expressly allot all your costs in between private usage and leasing use if you rent out a part of your own personal home. The IRS allows a little versatility with the method you employ; just make sure it’s consistent from year to year. Some people choose the option of taking the number of rooms within their residence along with the number of rooms within the home, and divide them. Dividing the rented sq . ft . by the residence’s total sq . ft . is another option that lots of people go for. You’ll end up with rental costs and personal costs. Those allotted to the leasing income can be deducted as such, and you can use Schedule A of Form 1040 to deduct what’s left.

Bothell CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is the owner of his own small business, Huddleston Tax CPAs. He is a graduate of Washington State University and the University of Washington School of Law.

Actual Expenses

All expenses are logged as they pertain to travel costs connected with your rental property. IRS Publication 463, Chapter 5 describes exactly how all of these costs will be recorded and backed up with invoices and receipts. A number of software program apps are obtainable with iPod, Quick Books, Mint, and so on, which may help you; you will need to continue to keep a concrete documents to backup your deductions, as well. You should claim these in your Schedule C or Schedule E forms. For people with multiple rental properties, your expenses must be allocated to each individual residence where costs are accrued. Make sure to not add any sort of non-business use or any other use except that which is specifically connected to the rental property.

Mileage Method

You’d utilize the latest standard mileage taxation rate of $0.55.5 per mile for every mile you drive in the year.

All local transportation costs including automobile leases, metro bus service, and Zip Cars which you declare must be directly associated with your properties. When using public transportation save your stubs. When using Zip Cars and/or rental vehicles apply these costs to your business account in association with your property.

• You can obtain the different documents outlined in this information on the IRS’s webpage. For more information please reference IRS Publication 527.

Bothell CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

Quick Tip: The documents described in this article are available on the IRS’s website, at: http://www.irs.gov/Forms-&-Pubs. All the appropriate forms will likely be contained in any tax preparing software, should you use one.

Individual Ownership

Including mutual property ownership with a wife or husband, tenancy in common, or shared tenancy with legal rights of survivorship.

Form 1040. Foremost, you’ll require Form 1040, the tax form filed by all individual citizens. Your total leasing revenue or financial loss subjected to taxation will appear at line 17 of the first page in Form 1040. You are not able to work with the simplified Forms 1040A or 1040-EZ, as a landlord with rental property activity.

Schedule E. The addendum to Form 1040 you have to know about is Schedule E. Of this addendum’s diverse uses, just the use of reporting rental income and expenditures is important to yourself. The only section of Schedule E that you must finish is the part marked “Part I”. There are several essential notes you should be aware of, including: when you own the rental mutually with someone other than your husband or wife, report only revenue that you received along with the costs which you suffered. Bear in mind, additionally, that you’ll have to allocate expenditures relating to rental and non-rental usage should you be leasing a segment of your own home, or when you rented only for a part of the year. For more details, check out Tax Deductible Rental Property Expenses, the article collection that is available within this Guide.

Form 4562. Form 4562 is needed to quantify depreciation on your property, which you can deduct on line 18 of Schedule E. For further advice, find the article titled, Depreciation Expenses for Rental Property, that’s found in this Guide.

Partnership/Corporate Ownership

A general or limited partnership, or S corporation is included.

Form 1065/1120-S. The form a partnership employs to report each of its organization activities is Form 1065, that you will need to fill out when you have a partnership. Form 1120-S is utilized by an S corporation to report business operations. Your current net rental profit or loss are reported on Schedule K, line 2 of Form 1065 or 1120-S (Such forms are incorporated with Schedule K).

Form 8825. Form 8825 is for partnerships and S corporations, but works just like Schedule E. Schedule E and Form 8852 are basically very similar. Make sure you disclose total sums of any earnings and expenses suffered by the partnership or corporation (In the future, they should be allocated to each investor or business partner).

Schedule K-1. This document reports the total rental income or deficit attributable to each partner or investor relative to that business partner or investor’s property ownership interest. Every business partner receives his / her very own K-1 and must report the contents of the K-1 on their own Form 1040, Schedule E, Part II.

Limited Liability Company Ownership

A single owner LLC is a disregarded entity for tax usage, so that you could file like you’re an independent property owner (see above). A multiple-member LLC can decide to be taxed either as a partnership or as an S corporation (look above).

Seattle CPA +John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

To claim this deduction you must be active (beyond depositing monthly checks). If you consistently spend a substantial amount of time maintaining and preparing properties, you will likely fit the term “active”.

If you meet the criteria for being an active rental property management the next requirement is that you must regularly use the office space exclusively for running your business as a rental property manager.

In addition to that, you must meet at least one of the following conditions:

1. Your home office is used as your principle place of business.

2. You must have no other location from where you run the administrative end of your property managment rental business.

3. You utilize this space to meet clients and potential clients.

4. You use a separate structure on your property for business.

After you have applied the threshold tests above and determined that the work area in your home does in fact meet the requirements for the home office deduction, you’ll have to look into what kind of expenses are tax deductible. There are direct and indirect types. Direct expenses solely benefit the home office area of the home such as cleaning or painting. Indirect expenses benefit the entire home and must be apportioned out between the office space and the rest of the house. Property tax, insurance, mortgage interest, and utilities are examples of indirect expenses. Square footage is the common way of determining the proportion of the home office in relation to the entire house to come up with a percentage. A 2,000 square foot home with a 200 square foot home office area would mean 10% of the indirect expenses could be deducted as part of the home office deduction. You can also depreciate the house structure (not the value of the land) in the same percentage over 40 years. However, this may complicate matters if you sell the house.

Because you don’t want any trouble if you do get audited, you want to maintain good records to demonstrate that you were/are entitled to take the deduction and that the claim has been accurately reported. You should document the home office space by a diagram and/or photograph that supports your square footage calculation. It is advisable to use your home office address on your business cards and other forms of communication and to have business mail delivered there. You should maintain a log of client meetings and other time spent working there. Records you should keep to substantiate expenses include: property tax statements, utility bills, insurance premium notices, 1098 mortgage interest statements and receipts for other relevant home office expenses.

This process can get quite complex and the aforementioned is only intended to give you a basic understanding of the circumstances that would allow you to take advantage of the home office deduction.

Bothell Tax CPA +John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

Interest

The primary type of interest you will most likely be deducting is interest on the mortgage. If you are renting the property as its own living unit, you can deduct all of the mortgage interest you paid on Schedule E. Meanwhile, if you are renting a room in your home, or if it’s a duplex and you’re living in the other unit, then you’ll have to pro rate the mortgage expense. See the article titled Personal Use of Rental Property, included in this guide, for more on how to calculate personal use. Personal use mortgage interest always goes on Schedule A of your Form 1040 (not on Schedule E). Additionally, if you own only a part interest in the rental, you will need to multiply the total amount of mortgage interest paid on the property by your ownership interest. Be aware, however, that certain expenses you pay to obtain a mortgage (such as title/recording fees and commissions) are capitalized as part of your depreciable basis for the property, and are not expensed. See the article titled Depreciation Expenses for Rental Property, included in this Guide, for more on depreciation expense. Other types of interest may also be deductible, if you incurred the interest solely for the benefit of the rental property. For example, if you took out a personal loan in order to replace carpeting, or fix the roof.

Advertising

Promoting a rental property on the open market, through marketing efforts such as posting newspaper ads or paying for internet marketing, is a tax deductible expense.

Professional fees

You can deduct professional fees you incur in connection with the rental. For example, if you paid an attorney to draft a lease, or to initiate court proceedings to evict a tenant, you may deduct these fees. And additionally, it’s possible to deduct cost paid to a CPA for preparing the Schedule E of your tax return from the past year. Make sure to pro rate the total preparation fee between the Schedule E and the remainder of your return dependent upon the percentage of time it took. Any fees for preparation of any part of the return other than Schedule E will go on Schedule A as personal tax prep expense. Finally, in the event that you pay any management fees or commissions to a professional realtor for managing your rental, you can deduct these expenditures too.

Bothell Tax CPA +John Huddleston has written prolifically on accounting and other tax related topics of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

NOTE: The expenses we will look at here in this write-up aren’t the same types of expenses that qualify as a deduction within Internal Revenue Code section 195. Within this section 195, certain expenses incurred as startup expenditures in an active business or active trade are deductible up front up to $5,000, with the balance amortizable over fifteen years. However, in this section of the Internal Revenue Code, rental activity is not included because rental activity is considered a passive activity not as an active business or trade. Find further information on passive versus active rules in the Tax Deductible Rental Losses article.

Note: It is not just when you have actually rented a property that rental activity “begins”, but when you’ve made the property available for rent or you have it out on the market.

Obtaining a Mortgage Expenses Incurred

Expenses such as mortgage commissions, abstract fees, and recording fees, are capitalized and come to be part of your basis in the property. And this means that you must depreciate these expenses, instead of expensing them all at once. Read the Depreciation Expenses for Rental Property article, included in this Guide, for a more in depth discussion on depreciation.

Points

“Points” are charges paid by a borrower to take out a loan or a mortgage. These charges may also be called loan origination fees, maximum loan charges, or premium charges. Points are deductible as interest, but require that you amortize the points over the life of the loan. Figuring out the quantity of points to amortize per year is a complicated process beyond the scope of this article. Talk with a tax professional.

Improvements vs. Repairs

You must depreciate and capitalize improvements you make to the property prior to putting it on the market. Improvements prolong the use of the property or materially add to the property’s market value. On the other hand, you may freely deduct all repair expenses. A repair maintains your property in good working condition without adding to its value or prolonging its use.

Bothell Tax CPA +John Huddleston is a graduate of Washington State University and the University of Washington. He has written many articles on accounting and other tax related subjects.

Also seek the counsel of an attorney or a CPA prior to transferring the ownership of a rental property and establishing an entity. This guide isn’t a comprehensive replacement for specialized council.

TIP: Always consult with a tax attorney or CPA before establishing an entity and transferring ownership of a rental property. This Guide isn’t meant to be an all-in-one solution you should seek the attention of a qualified professional.

Individual Ownership

This is the most common and the most straight forward form of ownership and occurs when you purchase a rental property in your own name. This includes owning the property with your spouse, or as joint tenants or tenants in common with someone else. The main benefit is that this is straightforward and simple, and does not require you to file any complicated paperwork or pay any lofty filing fees. The principal disadvantage to this type of ownership is that your creditors could possibly force a sale of the rental property if they receive a mandate against you, or compel you into an involuntary bankruptcy.

Legal Entity Ownership

General partnerships, limited liability companies, and corporations are all legal entities. The differences between these entities are important and outlined below. The main advantage to entity ownership is that your personal creditors cannot force a sale of the rental property, because you don’t own it. The general partnership is the only type of entity that does not require registration with the Secretary of State. With regards to taxes, the type of entity chosen doesn’t matter very much because in most cases, rental income “passes through” from the entity and is taxed on a personal tax return (but do note the cautionary note under corporations). Cover the article entitled Necessary Tax Forms for Reporting Rental Activity, included in this Guide, for further discussion on just how rental income is taxed.

General partnership. This form of ownership takes place when two or more persons co-own a business for profit. Now with a general partnership the partners have equal management privileges, but also each partner is personally liable for the debts of this partnership. And thereby a general partnership is usually not preferred.

Limited partnership. This entity is more complex than the general partnership as it requires both one limited partner and a general partner. The general partner has sole management rights, along with personal liability for any resultant debts. While, the limited partner isn’t personally liable for debts of the partnership and at the same time has no management rights.

Limited liability partnership/company (LLPs or LLCs). A limited liability partnership and a limited liability company are very similar entity types, both providing for limited liability to partners/members. This means you are not personally liable for the debts of the entity, unless the debt is caused by your own wrongdoing. This kind of ownership is often preferable because of limited liability and there are fewer formalities to observe than with corporations.

Corporations. This mode of ownership offers you limited liability and also allows for perpetual existence. Although they also require the observance of certain formalities so as to maintain this limited liability status. Thus for this reason that LLCs and LLPs are generally more suitable to your aims. Also worth mentioning is that corporations fall under one of two categorizations: s-corp or c-corp. When a corporate entity is taxed as a c-corporation, it will pay tax on rental income, and then you’ll pay tax (again) when the c-corp pays dividends. And it’s preferable to side-step the double-taxation trap whenever it is possible.

Bothell Accountant +John Huddleston holds a masters degree in tax law and a juris doctorate from the University of Washington. He has written many tax related articles over the years.