If you're a real-estate professional, you report income and expenses from your rental homes like any other self-employed person. The IRS doesn't count most rental-home owners as professionals, however. If you earn what the IRS counts as "passive" rental income, you still pay tax on it, but the law limits how much you can write off when you run in the red.
Professional or Passive
You qualify as a real-estate professional if you put in more than 750 hours during the year in real estate, or if more than half of your work hours for the year are in real estate. Hours you spend working for someone else don't count unless you own at least 5 percent of the business. If you don't qualify as a pro, your rental income is passive unless you provide "substantial services" to your tenants. Maintenance doesn't qualify -- we're talking something above and beyond, such as providing tenants with maid service.
If you qualify as a professional or provide substantial services, you add up your rental income and expenses on Schedule C. If you end up with a loss, you subtract it from your other income on your 1040. Some of the money you spend isn't deductible as an expense: you can write off repairs, but you have to depreciate major improvements -- a new roof, for example -- over several decades. Report depreciation on Form 4562.
If the IRS counts your rental as passive income, you report it on Schedule E. If you have more than one property, you report income, expenses and depreciation separately for each, using multiple copies of Schedule E if need be. If one of your rentals operates at a loss, you subtract the red ink from the profits on your other rentals. If you have any red ink remaining, you either subtract it from your non-rental income or carry the loss over to another year.
If your rental income is passive, you can still write off up to $25,000 in rental losses from your other income, provided you materially participate in managing the property. Advertising vacancies, calling contractors for repairs and vetting tenants count as material participation; paying a property manager to do the work does not. If you have losses you can't write off this year, carry them over and subtract them from next year's rental income. You usually use Form 8582 along with Schedule E to figure and report passive losses.
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