Accurately reporting your rental income is an important part of tax law compliance and also helps paint a clear financial picture of your rental business. Misreporting, intentional or otherwise, can lead to penalties, audits, and an incorrect impression of how your portfolio is actually performing.
Schedule E, or the Supplemental Income and Loss form, is the form many rental property owners use to report rental income to the Internal Revenue Service (IRS). For tax purposes, the IRS defines rental income as any payment you receive for the use or occupation of your property, from monthly payments to advance rent and potentially even part of a tenant’s security deposit if it’s not returned.
In this article, we dive deep into the intricacies of Schedule E rental income reporting. We explain what constitutes fair rental days, guide you through filling out the Schedule E form, and discuss potential deductions and tax benefits.
Understanding the basics of Schedule E rental income
Before delving into the nitty-gritty of completing this IRS form, let’s clarify the types of income you may need to report.
Rental income
Your annual rental revenue is the most straightforward income to report on Schedule E, which includes your tenants’ rent payments. Publication 527 specifies that receiving money in exchange for allowing someone to use your property is rental income per the IRS.
Advance rent
If your tenant gives you an upfront payment to cover their rent for the year, you’d report this sum as advance rent. It doesn’t matter when the actual rental period is; the IRS requires that you report the income when it’s actually received.
Security deposits
Generally, security deposits aren’t included in your taxable income if you plan to return the funds to your tenants at the end of the lease. However, if you keep part or all of the deposit because your tenant didn’t fulfill the lease terms, you need to include that amount as part of your annual income. Presumably, you would then also have an offsetting expense line item for whatever repairs were associated with the retained security deposit funds.
Expenses paid by the tenant
What if your tenant pays for some costs related to the property, like necessary repairs or maintenance expenses? The IRS generally takes the position that you must report these payments as rental income since you, as the owner of the property, are benefitting from your tenant’s generosity.
Property or services
Occasionally, you may receive property or services as rent instead of money. A tenant painting the outside of the house in exchange for a rent credit is one example. If this occurs, you need to determine the fair market value of what you received and report that value as rental income since this is essentially the same as an “expense paid by the tenant.”
Potential deductions that landlords can claim on their Schedule E
Maximizing tax deductions helps reduce your tax liability and contributes to the overall profitability of your rental property investments. However, it’s crucial to do this while staying within the bounds of the law. Understanding what you can and can’t deduct can prevent complications with your return.
Here are some, but certainly not all, of the potential deductions and expense categories landlords can claim on Schedule E:
- Mortgage interest: If you have a mortgage on your rental property, the interest you pay is often deductible.
- Property tax: Local and state property taxes paid on your rental property are usually deductible and typically are not subject to any caps as long as the properties are held for investment purposes.
- Insurance premiums: You can typically deduct the cost of insuring your rental property.
- Maintenance and repairs: Make sure to deduct routine maintenance and necessary repairs to keep your property in good working condition.
- Depreciation expense: As mentioned earlier, depreciation allows you to spread out the cost of buying or improving your property over its useful life.
- Travel expenses: If you travel to your rental property for business purposes, these expenses can be deductible in certain situations.
- Home office: If you use part of your home exclusively for managing your rental property, you may be able to deduct a portion of your home expenses if certain key tests are met.
- Legal and professional services: Payments to attorneys, accountants, property management companies, real estate investment advisors, and other professional fees can be deductible if they relate to your rental activity.
- Advertising and leasing expenses: Things like commissions paid to a leasing agent, costs associated with screening tenants, and listing your vacant property on listing sites are typically tax deductible expenses.
Again, you must keep accurate and detailed records of your expenses to claim these deductions. The rules around them can be complex so be sure to consult with a qualified tax advisor and/or CPA before making any decisions.
Reporting Schedule E rental income: A step-by-step guide
Step 1: Gather your records
Before filling out Schedule E, compile all the necessary records. Include your rental income statements, expense receipts, travel logs, and records of personal versus rental use days. Having this information at the ready simplifies the tax preparation process. If you don’t have an automated system for tracking these items, check out Stessa.
Step 2: Fill out the top section
The first section of Schedule E asks for basic details, such as your name and Social Security number. Make sure this information matches your Form 1040.
Step 3: Detail your properties
In Part I, list the details of each rental property you own. Document the type of property, its location, and the number of days it was actually rented by tenants versus used for personal purposes.
Step 4: Report your income and expenses
Next, report your rental income and expenses for each property. Record information like rent received and costs like repairs, utilities, insurance, advertising, and depreciation. Remember, only report expenses that were necessary to rent the property.
If this is something you want to automate, check out Stessa.
Step 5: Calculate your net income or loss
Now, subtract your total expenses from your total rental income to calculate your net rental income or loss. You must do this for each rental property you own.
Step 6: Complete the rest of the form
Sections II, III, and IV cover income or loss from partnerships, S corporations, estates, trusts, and real estate mortgage investment conduits (REMICs). Fill out these areas if any of them apply to your properties.
Step 7: Review and attach to your tax return
Once you complete Schedule E, review it carefully for accuracy. Then, attach it to your Form 1040 and submit it with your tax return.
Tips for ensuring accuracy and compliance
- Keep detailed records. Maintain meticulous records of your rental income and expenses. Doing so makes filling out Schedule E easier, and these records are invaluable if the IRS ever questions your return.
- Understand deductible expenses. Not all expenses related to your rental property are deductible. Be sure you know what costs you can and can’t deduct.
- Track fair rental and personal use days. Accurately tracking these days is crucial for correctly reporting your income and expenses.
- Consider working with a professional. The process can be overwhelming, and we strongly recommend seeking help and counsel from a tax expert. They can provide valuable guidance and ensure you report your rental income correctly.
You can learn more about Schedule E (Form 1040) on the IRS website.
An important note on fair rental days
Fair rental days can play a significant role in your Schedule E form. These are the total number of days you actually rented your property to tenants at its fair market value, not when it was available for rent.
Understanding and accurately calculating your fair rental days is essential. It directly impacts the reporting of your rental income and expenses and is the basis for determining whether your property is considered a rental property for tax purposes.
How to calculate fair rental days
Suppose you own a vacation home. You rent it out for 300 days of the year and use it for personal use for 25 days. The 300 days would be your fair rental days. Your property would qualify as a rental property because your personal use didn’t exceed the greater of either 14 days or 10% of the total days rented to others at a fair price (in this case, 30 days).
Next, the IRS allows you to deduct certain expenses related to your rental activity. However, the deductible amount is prorated based on the number of fair rental days versus the total days the property was in use.
How does this impact your allowable rental expenses? If your annual rental expenses amount to $15,000, you would calculate the portion attributable to your rental use as follows:
- Divide your 300 fair rental days by your total days of use (300 rental days + 25 personal use days = 325 days). That equals approximately 0.92 or 92%.
- Multiply this percentage by your total rental expenses ($15,000).
- The total rental expenses you could potentially deduct is $13,800.
Remember, you can’t deduct expenses related to your personal use days. Increasing personal use can decrease the portion of your deductible expenses and may potentially disqualify your property from being claimed as a rental.
Tracking your fair rental and personal use days ensures accurate tax reporting and maximizes your tax benefits.
5 common mistakes landlords make when reporting Schedule E rental income
Making mistakes is easy, even for landlords with years of experience. Let’s look at some of the most common errors and misconceptions landlords encounter when filling out Schedule E.
1. Not separating personal and rental expenses
One common mistake is mixing personal expenses with rental expenses. Keeping these separate is critical because the IRS only allows deductions for expenditures incurred for rental purposes. Personal use expenses, even if they occur on your rental property, are not deductible.
2. Incorrectly reporting rental income
Rental income includes more than just the monthly payments you receive. It also encompasses advance rent, expenses paid by tenants, and the fair market value of services or goods exchanged for rent. Overlooking these forms of income can lead to tax reporting errors.
3. Overlooking depreciation
Depreciation may seem complex, but it’s a valuable tool that can reduce your taxable rental income. Depreciation allows you to spread the cost of buying or improving your property over its useful life, so be sure to factor it in on your Schedule E.
4. Failing to report rental real estate activity
You must report all rental real estate activity on Schedule E, even if you didn’t earn income or incur expenses. Failure to do so can lead to penalties and complications with the IRS.
5. Misunderstanding passive activity rules
The IRS has specific rules about using losses from passive income activities (like most rental real estate) to offset other income. Know and adhere to these rules to avoid mistakes in reporting your rental income and losses.
Use Stessa to make Schedule E reporting easier
Mastering Schedule E reporting helps you maintain financial transparency and sets up your rental business for success. Tax professionals are well versed in these matters and can provide guidance tailored to your situation, ensuring you optimize your benefits while staying compliant with the law.
In addition to consulting with qualified professionals, you can also leverage technology to streamline your rental income and expense tracking.
With Stessa, you can automate the tracking and categorization process according to Schedule E requirements. From generating financial reports and screening tenants to automating rent collection and offering resources to simplify tax preparation, Stessa helps landlords maximize returns while reducing the daily hassles of owning and managing rental property.
Stessa does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal, or accounting advisors.
