At the end of the tax year, if you own real estate as an investment, you will be required to report the income for each individual property. This is typically done by filling out a Schedule E form, which is the part of the IRS form 1040 that handles supplemental income and losses.
While Schedule E is also utilized for other types of passive income, such as royalties, this article will focus on it from the perspective of a real estate investor. This includes breaking down each of the Schedule E categories and what they mean for real estate investors.
To simplify the tax filing process, Landlord Studio’s default expense categories are in line with IRS tax requirements and match up with the Schedule E tax form. By utilizing the app, you can instantly generate a Schedule E report that includes all of the information you entered during the tax year. This allows you to easily copy the information across to quickly and easily file an accurate end-of-year tax return and ensure you claim every allowable deduction.
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The IRS Schedule E Tax Form 1040 and Landlord Studio’s Schedule E Report
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What Is Schedule E?
A common question many real estate investors ask is “What is Schedule E and do I need one?” In short, the IRS Schedule E form is for reporting Supplemental Income and Loss, such as rental income or income from royalties. You fill out the Schedule E form as a part of your personal tax return form 1040.
Real estate is one of the most common reasons you might find yourself filling out a Schedule E form. It allows you to declare the income you received by renting your property to tenants and the expenses you’ve accrued over the year, broken down by property and into 15 expense categories which we detail later on in this article. Generally, rental income is deemed to be passive. However, if you offer a variety of services and materially participate in the management of the property you may be required to file a Schedule C rather than Schedule E tax form.
You only need to fill out the parts of the IRS Schedule E form that relate to the type of income or loss you incur. For example, if you have partnership income, just fill out the section that applies to partnerships. You must attach the Schedule E tax form to your personal Form 1040 and submit it by the filing deadline.
Download the IRS Schedule E Form from the IRS website.
Schedule E for Rental Real Estate
As mentioned above, Schedule E is for recording income and expenses accrued through real estate activities. Most real estate investors will be required to fill out an IRS Schedule E form. However, there are several exceptions. If you’re uncertain, it’s worth discussing your tax filing requirements with your financial advisor or CPA.
The designation of rental income as passive has several implications for business owners:
- Deductions or losses from passive activities are limited
- Since rental income is passive rather than active, you are not considered self-employed and you don’t have to pay self-employment tax (Social Security and Medicare tax) on this income.
Part 1 of the Schedule E Form
To understand what you’ll need to pay in taxes and what counts as Schedule E deductible expenses, let’s look at each of the sections of the Schedule E tax form in turn.
Calculating total taxable income for your rentals
Part 1 of the Schedule E form is where you figure out the taxable profit (or loss) from your rental business for that year.
In the top section, fill out the property detail information, including address, type of property, how many days you rented the property, and how many days you personally used the property.
There’s also a box you can check labeled “QJV,” which stands for “qualified joint venture.” This is a special status box for those who own an investment property jointly with a spouse. You cannot check the box if this is a joint venture with anyone other than your spouse.
Next, you will need to list the total rental income for the period followed by your expenses, broken down by category. Below, we’ll take a detailed look at each of the Schedule E deductible expense categories.
A Breakdown of the Schedule E Form Expense Categories
There are 15 expense categories on the Schedule E tax form. Some are fairly self-explanatory, such as advertising expenses, whereas others require a little more explanation. Below we go through each of the categories to make sure you’re using them correctly.
Advertising
When searching for new tenants, you will likely need to take action to market your property. Any out-of-pocket expenses for the purpose of advertising your property are deductible business expenses. This includes things like newspaper ads, yard signs, online listing costs, online ads, and website expenses, etc.
Auto and travel
Travel can make up a large deductible expense. You’ll likely need to travel between properties for business purposes – such as routine inspections and showing properties. Auto and travel expenses include vehicle mileage (the Internal Revenue Service allows a deduction of $0.56 per mile in 2021), airfare, and half of the meals you purchase while traveling.
If your rental properties are local travel isn’t likely to be a major expense, but if you own faraway vacation rentals, it could add up to a substantial deduction.
If you do deduct travel expenses make sure to keep careful records, such as a mileage log, with the details and purpose of the trip. The IRS often chooses to closely scrutinize travel expenses, especially if they’re substantial.
Cleaning and maintenance
You can deduct cleaning and any routine maintenance costs. Examples that fit within this category include gardening or lawn care, pest control, snow removal, and pressure washing of the building exterior. This includes the cost of labor as well as any supplies you bought specifically for this purpose.
Commissions
Commissions are generally considered a business expense, meaning they are normally deductible. They include commissions to someone to find you a tenant but not any commissions you pay to a real estate agent when buying a property.
Insurance
Maintaining an insurance policy on your rental property is good business practice — very few real estate investors don’t have at least one policy per property. You may also have additional insurance policies for things like flood protection.
Regardless of the type or number of policies you have, insurance premiums are deductible as a rental property business expense.
Legal and other professional fees
Legal and professional fees aren’t just for worst-case scenarios such as managing an eviction. There are various more standard reasons why you may contact a lawyer or professional to help you with your investment property. A few examples include asking a lawyer to oversee paperwork, such as new lease documents, fees for tax preparation, and CPA costs. If you use property management software like Landlord Studio, you can also deduct these fees.
All of the above are considered operating expenses. You cannot, however, deduct legal fees used to defend the title of your property or to recover and improve the property.
Management fees
Property management fees are generally between 8 and 12 percent of your monthly rental income. The good news is that if you do contract a property management service, their fees are generally deductible.
Mortgage interest
Many landlords build wealth through real estate by leveraging through loans to invest in property. Your mortgage will likely make up a large expenditure for your business. Investment property owners can list their mortgage interest as a business expense on the IRS Schedule E form.
It’s important to note that only the interest is deductible, not the mortgage principal. When recording your expenses, it’s a good idea to track interest separately.
Other interest
You can also deduct interest from other loans, including interest on credit cards, provided you incurred the expenses wholly through actions to improve or repairs to the property.
Additionally, you can deduct interest from loans from non-bank lenders. Generally speaking, if you have interest on a loan but don’t receive a Form 1098 mortgage interest statement, you can report this interest as a deductible expense.
Repairs
The cost of making repairs to a property is deductible. Examples of repairs include fixing broken plumbing or a broken cupboard door, etc.
It’s important to note that you can’t deduct the cost of any improvements you make to the property. Improvements might be anything from a loft conversion or new conservatory to replacing (rather than repairing) kitchen appliances. Instead, you need to add capital improvements to your cost basis and depreciate them.
Since there are some gray areas when determining what is a repair and what is an improvement, it’s worth discussing any doubts you have with your CPA to make sure you categorize expenses properly.
A good rule of thumb is that a repair is necessary to keep the property in good working order but doesn’t increase the property’s market value. In contrast, a capital improvement is a modification that adds significantly to the fair market value of the property.
It’s also worth pointing out that all deductible rental property expenses (repairs and otherwise) must be ordinary and necessary. If you need to spend $100 to repair a faucet but you instead spend $500 replacing the entire sink, this may not qualify as a deductible expense.
Supplies
Supplies is a pretty broad category. It normally refers to any office equipment you purchased to manage your property and other supplies you’ll use exclusively for your rental properties.
An example of this could be notepads or, if you self-manage, you may purchase a toolkit for property maintenance.
Taxes
You can record any property taxes you pay to your local government as a Schedule E deductible expense. You can also deduct any taxes or fees associated with permissions to rent the property, such as local licensing fees or occupancy taxes.
Utilities
All landlords handle utilities differently. Some pass the expenses on to their tenants; some have their tenants set up their own connections or move the bills into their tenants’ names. However, if you cover things like gas, electric, water, heating, AC, or internet for your tenants, you can deduct these as utility expenses.
If your tenant agrees to reimburse you for utilities at a later date, you can continue to file this expense as a deduction, but you will also need to record the reimbursem*nt as income later.
Depreciation expense or depletion
Properties (not the land itself) are considered assets with a value that reduces over the period of your ownership due to wear and tear. As such, residential rental properties can be depreciated over 27.5 years and the value deducted.
You can start claiming depreciation as soon as your property is ready for rent — this generally means when you start advertising. It’s important to make sure you claim the maximum amount of depreciation you are entitled to because the IRS will reclaim some of the depreciated value through a process called depreciation recapture when you eventually sell the property.
You can also depreciate the value of equipment you use in the management of the property or for improvements.
Other (list)
If you have any further expenses related to the ownership, maintenance, or management of your property, list them under the Other section. If you aren’t 100 percent sure something is deductible, seek advice from a qualified tax professional.
Final Words
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IRS Schedule E is part of Form 1040, used to report the income and loss of supplemental income sources. This is income not earned through active business activity, such as your regular employment.
Supplemental income is considered passive income, such as collecting rent. Of course, as a landlord, you know that rental income is anything but passive. However, passive is how the IRS sees it.
To ensure you file an accurate tax return at the end of the year and maximize your potential deductions while avoiding mistakes that could put you in trouble with the IRS, you need to keep meticulous records of your income and expenses, which includes storing documents that prove your claims. This is where Landlord Studio comes in.
With Landlord Studio, you can track income and expenses on any device at any time, generate professional reports instantly, easily digitize receipts, and store documents on our secure cloud server.
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