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1 Liberty Tax Service Online Basic Income Tax Course. Lesson 15.

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1 1 Liberty Tax Service Online Basic Income Tax Course. Lesson 15

2 2 Chapter 14 Homework HOMEWORK 1: Ken E. (SSN 555-00-4321, born 12/6/1969) and Mary Ellen Busser (SSN 543-00-2221, born 11/13/1971) are married and file a joint return. They live at 608 South Apollo St., Virginia Beach, VA 23462. They have no dependents. Ken works as a drug counselor. In 2008, Mary Ellen began making crafts and selling them at a local store. She received a Form 1099-MISC from Krafty Krafts for the sale of her crafts. She spent $450 for materials and supplies to make her crafts. Her principal business code is 424990. The Bussers are taking the standard deduction. Complete a tax return for the Bussers.

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14 14 Chapter 14 Homework HOMEWORK 2: Thomas R. Zawady (SSN 333-11-2334, born 3/12/1958) is single, and runs a bookkeeping business out of his house at 8829 Plain Ave, Bismarck, ND 58503. He uses one of eight rooms in his house for his business. He meets the qualifying tests for his home office. He uses the cash method of accounting. In 2008, he had gross receipts of $38,345.

15 15 Chapter 14 Homework Tom’s expenses for 2008 are the following: Mortgage interest $3,945 Real estate taxes $1,300 Home insurance 550 Utilities 1,380 Advertising 450 Supplies 1,060 Business cards 65 Office expenses 120 Painting the office 125 The local sales tax rate for Bismarck is 1%. Tom placed his car in service on May 13, 2007. He used the standard mileage rate. Tom drove 2,355 miles for business in 2008 (1,235 miles from 1/1/2008 to 6/30/2008) and he drove 11,215 personal miles. It is his only vehicle and he has written records.

16 16 Chapter 14 Homework Tom started his bookkeeping business in October 1998. The adjusted basis of his house was $100,000 including a land value of $20,000. The FMV of his house was $115,000 including a land value of $25,000. Other expenses Tom paid in 2008 were: Medical bills $ 880 Dental costs $660 Charitable State balance paid contributions* 1,099 with 2007 return 550 * No single gift of $250 or more. After adjusting for one-half of self-employment tax, Tom’s AGI is $31,684. Complete Schedules A, C, SE and Form 8829 for Tom.

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28 28 Chapter 15: Rental Real Estate, Royalties, Partnerships, etc. Chapter Content Rental Real Estate Rental Income Rental Expenses Deduction Limits Based on Property Use Personal Use of a Vacation Home or Dwelling Unit Limits on Rental Losses Reporting Rental Income and Expenses Other Schedule E Income Key Ideas Objectives Understand Rental Income and Expenses Become Familiar with Schedule E

29 29 Rental Real Estate, Royalties, Partnerships, etc. I. I.Schedule E A. Use Schedule E to figure income and loss from rental activities and other supplemental income producing activities. B. Do not use Schedule E for: 1. Rental income from the rental of personal property 2. Some types of royalties, such as those subject to SE tax. C. Enter the net income or loss on line 17 of Form 1040. Form 1040, Page 1

30 30 Rental Real Estate, Royalties, Partnerships, etc.

31 31 Rental Real Estate, Royalties, Partnerships, etc.

32 32 Rental Real Estate, Royalties, Partnerships, etc.

33 33 Rental Real Estate, Royalties, Partnerships, etc.

34 34 RENTAL REAL ESTATE You are taxed on the amount of rental income that exceeds your related expenses, including depreciation. If your expenses are greater than the rents you receive, you have a loss. There are special rules related to expenses for property used partly for business and partly for personal purposes. There are also special rules called “passive activity loss rules” which may limit the amount of the loss you can claim. Report rental income in the year you actually or constructively receive it. You constructively receive income when it is made available to you, as when it is credited to your bank account.

35 35 RENTAL REAL ESTATE Rental Income A. Any amount you receive for the use or occupation of residential or nonresidential property is rental income that must be included in gross income. B. In addition to rent payments, rental income includes: 1. Advance rent 2. Cancellation of lease payments 3. Expenses paid by a tenant 4. The FMV services provided by a tenant 5. Any security deposit that is not returned to a tenant 6. Security deposit intended to be the last month’s rent is advance rent.

36 36 RENTAL REAL ESTATE In January 2008, Carry Ann signed a 5-year lease to rent her property. In 2008, she received $6,000 for the first year’s rent and $6,000 for the last year’s rent. She must include $12,000 in her income for 2008. Larry Landlord rents apartments. Prior to 2008, he paid a lawn service company $100 a month ($1,200 per year) to do yard work and plow in the winter. In 2008, he agreed to have one of his tenants do this work as part of the rent. Larry must include $1,200 in his gross rental income for 2008 and he can deduct $1,200 as an expense.

37 37 RENTAL REAL ESTATE Rental Expenses A. Deduct rental expenses in the year you pay or incur them. B. May be able to include certain expenses for property held for rent (NOT loss of rental income) while the property is vacant: 1. From the time the property is available for rent 2. Until the property is sold. C. If property is sometimes used for personal purposes, expenses must be divided between rental and personal use and the deductions may be limited.

38 38 RENTAL REAL ESTATE REPAIRS AND IMPROVEMENTS D. You can deduct expenses for repairs but not improvements. 1. A repair maintains the property 2. An improvement adds to the value of the property, prolongs its useful life, or adapts it to new uses 3. The cost of improvements is recovered by taking depreciation deductions 4. Refer to Table 15-1 for examples of improvements.

39 39 RENTAL REAL ESTATE

40 40 RENTAL REAL ESTATE – Problem 1 Roland bought a house to use as rental property in June 2008. He began advertising for tenants immediately. He did not rent the house until September 2008. He can deduct his ordinary and necessary expenses for managing, conserving, and maintaining the property starting in June 2008. He can also deduct the rent he lost while the house was vacant in June, July, and August. True or False?

41 41 RENTAL REAL ESTATE – Problem 1 Roland bought a house to use as rental property in June 2008. He began advertising for tenants immediately. He did not rent the house until September 2008. He can deduct his ordinary and necessary expenses for managing, conserving, and maintaining the property starting in June 2008. He can also deduct the rent he lost while the house was vacant in June, July, and August. False

42 42 RENTAL REAL ESTATE – Problem 2 Albert rents a house to James. From October 2008 until December 2008, James failed to pay the $600 per month rent. Albert cannot deduct the $1,800 that James failed to pay him as a rental expense. True or False?

43 43 RENTAL REAL ESTATE – Problem 2 Albert rents a house to James. From October 2008 until December 2008, James failed to pay the $600 per month rent. Albert cannot deduct the $1,800 that James failed to pay him as a rental expense.True

44 44 RENTAL REAL ESTATE – Problem 3 If Roland paints the interior of the house he is renting out, the cost is a deductible repair. If he puts an addition on the house, is this an improvement or a repair? a. Improvement b. Repair

45 45 RENTAL REAL ESTATE – Problem 3 If Roland paints the interior of the house he is renting out, the cost is a deductible repair. If he puts an addition on the house, is this an improvement or a repair? a. Improvement This is an improvement and the entire cost including any painting must be depreciated as if the addition were separate property.

46 46 RENTAL REAL ESTATE OTHER EXPENSES E. Auto and travel expenses are deductible if the main purpose of the travel is to collect rental income or to manage or maintain the rental property. 1. If you travel away from home, you can deduct 50% of your meals. 2. You must keep written records of all travel expenses and allocate expenses between rental and non-rental activities. 3. If you use your personal vehicle, you can deduct either the standard mileage rate (48.5 cents in 2007) or actual expenses for all business miles. 4. To deduct car expenses under either method, Part V of Form 4562 must be completed.

47 47 RENTAL REAL ESTATE Clay began renting apartments in the building he owns in June 2008. He drove to the building to collect rents, make repairs, and carry out other rental activities. His records show that of his total mileage of 23,000 miles in 2008 including 8,000 miles for rental activities. He drove 4,600 of these rental activity miles in the first six months of the year. Clay bought the car, a Ford Escort, on April 8, 2007 for $16,000. Using the standard mileage rate, his deduction is $4,312. He fills out Part V of Form 4562 as follows:

48 48 RENTAL REAL ESTATE

49 49 RENTAL REAL ESTATE F. Other deductible expenses include: 1. Advertising 2. Cleaning and maintenance 3. Commissions 4. Insurance 5. Legal and other professional fees (the part of the tax preparation related to preparing Part I of Schedule E) 6. Mortgage interest, supplies, taxes, and utilities

50 50 RENTAL REAL ESTATE DEPRECIATION G. You can deduct some or all of what you paid for income-producing property by taking yearly depreciation. 1. You will generally use MACRS to figure the depreciation deduction for property acquired or converted to rental use after 1986. 2. Do NOT include the land value in the basis of the real property. 3. Use the mid-month convention to depreciate real property. 4. Residential rental property is depreciated over 27.5 years under MACRS.

51 51 RENTAL REAL ESTATE 5. Nonresidential real property is depreciated over 31.5 years if placed in service before 5/13/1993 and over 39 years if placed in service after 5/12/1993. 6. Personal property used in rental activities (appliances, furniture) is depreciated using the half-year or mid-quarter convention. 7. Certain personal property (appliances, furniture, carpets, etc) used in the rental property is classified as 5 year property. 8. Refer to Table 15-2 for a summary of the MACRS recovery periods for property used in rental activities.

52 52 RENTAL REAL ESTATE

53 53 RENTAL REAL ESTATE YOU CANNOT CLAIM A SECTION 179 DEDUCTION FOR PROPERTY USED IN RENTAL ACTIVITIES. There are certain types of property eligible for an additional 50% (or 30% if applicable) special depreciation allowance. These properties are primarily limited to the following:   Qualified Liberty Zone property   Qualified Gulf Opportunity Zone (GO Zone) property   Qualified Recovery Assistance property ( property in the Kansas disaster area)   Qualified disaster assistance property (property in federally declared disaster areas)   Certain qualified property placed in service after December 31, 2007, and before January 1, 2010.

54 54 RENTAL REAL ESTATE Deduction Limits Based On Property Use A. Not-for-profit rental property is property that is rented at less than the fair rental price of the property. 1. Deduct only expenses that do not exceed income 2. Deduct only if you itemize deductions on Schedule A; do not use Schedule E 3. Do not carry forward any expenses that exceed income 4. Report income on line 21 of Form 1040.

55 55 RENTAL REAL ESTATE – Problem 4 Buddy and Dolores rented their upstairs flat to their cousin for $100 per month, which is less than the fair rental value of the property. They are not considered to be renting for a profit. They report the $1,200 income on line 21 of Form 1040. Can any of their expenses be deducted? Yes or No?

56 56 RENTAL REAL ESTATE – Problem 4 Buddy and Dolores rented their upstairs flat to their cousin for $100 per month, which is less than the fair rental value of the property. They are not considered to be renting for a profit. They report the $1,200 income on line 21 of Form 1040. Can any of their expenses be deducted?Yes Any expenses they have (not exceeding $1,200) can be deducted on Schedule A, line 23, if they itemize their deductions.

57 57 RENTAL REAL ESTATE PROPERTY CHANGED TO RENTAL USE B. If you change property from personal to rental use after the beginning of the year, allocate yearly expenses between rental and personal use. 1. Depreciation basis for rental use is the LESSER of the FMV on the date the property is changed to rental use or the adjusted cost basis. 2. Deduct rental expenses on Schedule E. 3. Personal use mortgage interest and taxes (not depreciation or insurance) may be deducted on Schedule A if you itemize deductions. Luke and Kate moved from their personal residence on June 30, 2008 and started renting it on July 1, 2008. They can deduct, as rental expenses on Schedule E, one-half of their yearly expenses, such as taxes and insurance.

58 58 RENTAL REAL ESTATE PROPERTY PARTLY USED FOR RENTAL PURPOSES C. If you rent part of your property and use a separate part for personal purposes you must divide expenses as if you had two separate pieces of property. 1. Expenses for the rental part of the property may be deducted from rental income on Schedule E. 2. You can deduct as a rental expense the entire cost of expenses that belong only to the rental part of the property. 3. You can deduct part of some expenses (mortgage interest, property taxes) as a rental expense and part as a personal expense on Schedule A if you itemize deductions. 4. You can deduct depreciation on the rental part of the property only. 5. You can use any reasonable method to divide expenses. 6. The most common method is based on square footage.

59 59 RENTAL REAL ESTATE Ma Perkins rents a room in her house. The room is 180 square feet. The house has 1,800 square feet of floor space. Ma can deduct as a rental expense 10% (180 is 10% of 1,800) of any expense that must be divided between rental use and personal use. If her heating bill for the year for the entire house was $600, she can deduct $60 ($600 x 10%) as a rental expense. The balance, $540, is a personal expense and cannot be deducted. If Ma paints the room she rents or puts in a second phone line for her tenant, 100% of these costs are deductible as rental expenses.

60 60 RENTAL REAL ESTATE Personal Use Of A Vacation Home Or Dwelling Unit A. Dwelling unit includes houses, apartments, condominiums, mobile homes, boats, and similar property. Birdie rents out a room in her home that is always available for short-term occupancy by paying customers. She does not use the room herself, and only paying customers are allowed to use the room. The room is considered a hotel, motel or similar establishment and is not a dwelling unit.

61 61 RENTAL REAL ESTATE USE AS A HOME B. If you have any personal use of a dwelling unit, you must divide expenses between personal and rental use. 1. Rental use is limited to the days the property is actually rented. C. If you use the dwelling unit as a home, you are also limited in the deductions you can take. D. You use a dwelling unit as a home if you used it for personal purposes more than the greater of: 1. 14 days, or 2. 10% of the total days it is rented at a fair rental price.

62 62 RENTAL REAL ESTATE E. A day of personal use of a dwelling unit is any day it is used by: 1. You or any other person who has an interest in it. 2. A member of your family or a member of the family of any other person who has an interest in it, unless the family member uses the unit as his or her main home (the home lived in most of the time) and pays a fair rental price. 3. Anyone under an arrangement that lets you use some other dwelling unit. 4. Anyone at less than a fair rental price. F. For purposes of determining if the dwelling unit is used as a home, count as a day of personal use any day you used it for personal purposes while it was rented.

63 63 RENTAL REAL ESTATE – Problem 5 Steve rented out a bedroom in his home at a fair rental price for a total of 27 days during several weekends the local college team played at home. His brother stayed in the room rent free for 21 days that same year. Are Steve’s expenses subject to the deduction limits? Yes or No?

64 64 RENTAL REAL ESTATE – Problem 5 Steve rented out a bedroom in his home at a fair rental price for a total of 27 days during several weekends the local college team played at home. His brother stayed in the room rent free for 21 days that same year. Are Steve’s expenses subject to the deduction limits? Yes Twenty-one days is more than the greater of 14 days or 10% of the total of 27 days that it was rented, so the room was used as a home. Steve’s expenses will be subject to the deduction limits.

65 65 RENTAL REAL ESTATE – Problem 6 Lauren owns a vacation condominium in Miami, which she rented at a fair rental price for 160 days in 2008. In July of 2008, she swapped units with a friend in Boca Raton. The friend stayed rent free at Lauren’s condominium and Lauren stayed rent free in Boca Raton for 15 days. The condominium was not used as a home because it was not used for personal purposes more than 16 days which is the greater of 14 days or 10% of the total days it was rented at a fair rental price (160 days). Are Lauren’s expenses subject to the special deduction limits? Yes or No?

66 66 RENTAL REAL ESTATE – Problem 6 Lauren owns a vacation condominium in Miami, which she rented at a fair rental price for 160 days in 2008. In July of 2008, she swapped units with a friend in Boca Raton. The friend stayed rent free at Lauren’s condominium and Lauren stayed rent free in Boca Raton for 15 days. The condominium was not used as a home because it was not used for personal purposes more than 16 days which is the greater of 14 days or 10% of the total days it was rented at a fair rental price (160 days). Are Lauren’s expenses subject to the special deduction limits? No Lauren still has to divide the expenses between rental and personal use, but her expenses are not subject to the special deduction limits.

67 67 RENTAL REAL ESTATE G. If the dwelling unit is your main home, do not count as personal use days the days before or after renting it or offering it for rent if: 1. You rented or tried to rent the property for 12 or more consecutive months, or 2. You rented or tried to rent the property for a period of less than 12 consecutive months and the period ended because you sold or exchanged the property.

68 68 RENTAL REAL ESTATE On February 28, Alex Marshall moved out of the house he had lived in for 6 years because he had accepted a job in another town. He rented the house at a fair market price from March 15 of that year to May 14 of the next year. On the following June 1, he moved back into his old house. To determine whether he used the house as a home, the days he used it as his main home from January 1 to February 28 and from June 1 to December 31 of the next year are not counted as days of personal use. If Alex had sold the property after renting it for six months, he would not have to count the time from January 1 to February 28 as days of personal use. If he had moved back into his old home after renting it out for only 8 months, he would have to treat the time before and after he rented it as personal-use days.

69 69 RENTAL REAL ESTATE This special rule for your main home applies only to determining if the dwelling is considered a home for purposes of limiting your deductions. It does not apply when dividing expenses between rental and personal use. Alex, from the above example, can deduct as rental expenses only the part of his expenses (mortgage interest, taxes, insurance, maintenance, etc.) incurred while he was renting the property.

70 70 RENTAL REAL ESTATE DIVIDING RENTAL AND PERSONAL EXPENSES H. Divide your expenses between rental and personal use days based on the number of days used for each purpose. 1. Count any day the unit is rented as a day of rental use even if you use it for personal purposes that day. 2. Do not count as a day of rental use any day that the property is available for rent but not rented.

71 71 RENTAL REAL ESTATE Callie owns a beach cottage which she rents for part of the summer. She lived in the cottage the last two weeks in May (14 days). The cottage is available for rent from June 1 through August 31. Callie could not find a renter for the first week (7 days) of June. After that, she had tenants who paid a fair rental price to rent the cottage until August 31, 2008. Over the July 4th holiday, the tenants let Callie use the cottage for two days while they visited relatives. They paid the rent for those two days. The cottage was not used at any other time during the year.

72 72 RENTAL REAL ESTATE June 1 through August 31 is 92 days. Of that time, the cottage was used for rental purposes for 85 days. Although it was available for rent, the first week in June is not counted as days of rental use because it was not actually rented. The two days Callie stayed over July 4th are days of rental use for figuring expenses because she received a fair rental price for those days. She used the cottage for personal use for 14 days (the last two weeks in May). The total use of the cottage was 99 days (14 days personal use plus 85 days rental use). Callie’s rental expenses are 85/99 (86%) of the expenses for the cottage.

73 73 RENTAL REAL ESTATE When determining whether she used the cottage as a home, Callie must count the days she stayed there in July as personal use days. Therefore, she had 16 days of personal use and 83 days of rental use for this purpose. Because she used the cottage for personal purposes more than the greater of 14 days or 10% of the days used for rental purposes, she used it as a home. If she has a net loss, she may not be able to deduct all of her rental expenses.

74 74 RENTAL REAL ESTATE FIGURING NET INCOME AND LOSS I. If you do not use the dwelling unit as a home, report all rental income and deduct all rental losses as you would with any rental property. J. There are special rules for figuring net income and loss for property used as a home. 1. If rented for fewer than 15 days, do not include any rental income in your gross income and do not deduct any expenses as rental expenses. 2. If rented for 15 days or more, include all rental income in your gross income. 3. If you had a net profit, deduct all your rental expenses. 4. If you had a net loss, your deduction for certain rental expenses is limited. 5. Refer to Table 15-3 to see how you figure the limits on rental deductions for a dwelling unit used as a home.

75 75 RENTAL REAL ESTATE – Problem 7 In 2008, Zeke rented his home for a week to delegates to the cheese producer’s convention and received $1,400 rent. This is the only rent he received during the year. Does Zeke have to report the $1,400 he received for rent? Yes or No?

76 76 RENTAL REAL ESTATE – Problem 7 In 2008, Zeke rented his home for a week to delegates to the cheese producer’s convention and received $1,400 rent. This is the only rent he received during the year. Does Zeke have to report the $1,400 he received for rent? No No he does not but he cannot deduct the cost of utilities, maintenance, etc. for that week.

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78 78 RENTAL REAL ESTATE Limits On Rental Losses A. Rental real estate activities for which you receive income mainly from the use of tangible property are considered passive activities. 1. The amount of passive activity loss you can deduct from non-passive income is limited by at-risk rules and passive activity rules. 2. These rules do not apply to a dwelling unit used as a home.

79 79 RENTAL REAL ESTATE AT-RISK RULES B. At-risk rules limit deductible losses from holding most real property placed in service after 1986. 1. Losses from real property placed in service before 1987 are not subject to at-risk rules. 2. Your loss cannot exceed the amount of money or property you have at risk at the end of the tax year. 3. The at-risk amount includes: your cash investment; the adjusted basis of other property you paid for the rental property; loans for which you are personally liable.

80 80 RENTAL REAL ESTATE PASSIVE ACTIVITY LIMITS C. Rental activities are passive activities and you generally cannot offset non-passive income with rental losses. 1. Rental activities in which you materially participated are not passive activities if you were a real estate professional.

81 81 RENTAL REAL ESTATE SPECIAL LOSS ALLOWANCE D. If you actively participated in a passive rental activity, you may be able to deduct a special loss allowance of up to $25,000 of loss from non-passive income. 1. To actively participate, you must own at least 10% of the rental property and make significant and bona fide management decisions. 2. The special loss allowance is reduced to up to $12,500 if married filing a separate return and lived apart from your spouse for all of the year – NO loss if married, filing a separate return and lived with your spouse at any time. 3. There is a phase-out of the allowance based on modified AGI.

82 82 RENTAL REAL ESTATE In 2008, Pat received Form W-2 wages of $33,000, taxable interest income of $500, and dividend income of $1,200. This is all non-passive income. He also had a $3,500 loss from the apartment house he owns. Pat advertised and rented the units himself. He collected the rents and arranged for repairs. Because Pat owned 100% of the rental property and made significant and bona fide management decisions, he can use the entire $3,500 loss to offset his other non-passive activity income even though the loss was from a passive activity.

83 83 RENTAL REAL ESTATE Reporting Rental Income And Expenses A. Use Part I of Schedule E for most rental expenses. 1. Do not report not-for-profit activities on Schedule E 2. Use Schedule C if you provide significant services for your tenant’s convenience. B. If you have more than 3 rental properties, complete as many Schedules E as are needed. 1. Combine the totals on only one Schedule E. 2. Attach all the schedules to Form 1040. C. Attach Form 4562 for depreciation deductions, if required.

84 84 RENTAL REAL ESTATE The following example shows how to report your rental income and expenses. In January, Eileen E. Johnson bought a condominium apartment to live in. Instead of selling the house she had been living in, she decided to change it to rental property. Eileen selected a tenant and started renting the house on February 1, 2008. Eileen charges $750 a month for rent and collects it herself. Eileen received a $750 security deposit from her tenant. Because she plans to return it to her tenant at the end of the lease, she does not include it in her income. Her house expenses for the year are as follows: Mortgage interest......................................... $1,800 Fire insurance (1-year policy)............................ 100 Real estate taxes imposed and paid.................1,200 Miscellaneous repairs (after renting)................. 297

85 85 RENTAL REAL ESTATE Eileen must divide the real estate taxes, mortgage interest, and fire insurance between the personal use of the property and the rental use of the property. She can deduct eleven-twelfths of these expenses as rental expenses. She can include the balance of the allowable taxes and mortgage interest on Schedule A if she itemizes. She cannot deduct the balance of the fire insurance because it is a personal expense. Eileen bought this house in 1983 for $35,000. Her property tax was based on assessed values of $10,000 for the land and $25,000 for the house. Before changing it to rental property, Eileen added several improvements to the house. She figures her adjusted basis as follows:

86 86 RENTAL REAL ESTATE House......................................................... $25,000 Improvements Remodeled kitchen......................................... 4,200 Recreation room............................................. 5,800 New roof......................................................... 1,600 Patio and deck................................................ 2,400 Adjusted basis............................................ $39,000 On February 1, when Eileen changed her house to rental property, the property had a FMV of $152,000. Of this amount, $35,000 was for the land and $117,000 was for the house. Because Eileen's adjusted basis is less than the FMV on the date of the change, Eileen must use $39,000 as her basis for depreciation.

87 87 RENTAL REAL ESTATE Because the house is residential rental property, she must use the straight-line method of depreciation over either the GDS recovery period or the ADS recovery period. She uses the GDS recovery period of 27.5 years. She uses MACRS Table A-6 to find her depreciation percentage. Because she placed the property in service in February, she finds the percentage to be 3.182%. On June 1, Eileen bought a new dishwasher for the rental property at a cost of $425. The dishwasher is personal property used in a rental real estate activity, which has a 5-year recovery period. She uses the percentage under “Half-year convention” in MACRS Table A-1 to figure her depreciation deduction for the dishwasher. She finds the percentage to be 20%.

88 88 RENTAL REAL ESTATE On May 1, Eileen paid $4,000 to have a furnace installed in the house. The furnace is depreciated as residential rental property. Because she placed the property in service in May, she finds the percentage from MACRS Table A-6 to be 2.273%. Eileen figures her net rental income or loss for the house as follows:

89 89 RENTAL REAL ESTATE Total rental income received ($750 × 11) $8,250 Minus Expenses Mortgage interest ($1,800 ×11 /12) $1,650 Fire insurance ($100 ×11 /12) 92 Miscellaneous repairs 297 Real estate taxes ($1,200 ×11 /12) 1,100 Total expenses 3,139 Balance $5,111 Minus: Depreciation House ($39,000 × 3.182%) $1,241 Dishwasher ($425 × 20%) 85 Furnace ($4,000 × 2.273%) 91 Total depreciation 1,417 Net rental income for house $3,694 Eileen uses Part I of Schedule E to report her rental income and loss. She enters her income, expenses, and depreciation for the house in the column for Property A. She uses Form 4562 to figure and report her depreciation. Eileen's Schedule E and Form 4562 are shown on the following slides.

90 90 RENTAL REAL ESTATE

91 91 RENTAL REAL ESTATE

92 92 RENTAL REAL ESTATE

93 93 RENTAL REAL ESTATE

94 94 OTHER SCHEDULE E INCOME Royalties A. Royalties are payments for granting the right to use certain intellectual property such as a patent or to extract natural resources. 1. Payer of $10 or more in royalties should send you a Form 1099-MISC 2. Report income and expenses in Part I of Schedule E 3. If in business as a self-employed writer or artist, etc., use Schedule C.

95 95 OTHER SCHEDULE E INCOME Partnership And S Corporations B. Partnership and S corporation income is taxed to the partners or shareholders. 1. If you are a partner, your share of the income is reported to you on Schedule K-1 (Form 1065) 2. If you are an S corporation shareholder, your share of the income is reported to you on Schedule K-1 (Form 1120S) 3. Report your income and expenses and figure your losses in Part II of Schedule E.

96 96 OTHER SCHEDULE E INCOME Estates And Trusts C. Estates and trusts often generate income before the principal is distributed to the beneficiaries. 1. Your distributive share of income as a beneficiary of an estate or trust is reported to you on Schedule K-1 (Form 1041). 2. Report your share of trust income and losses in Part III of Schedule E.

97 97 OTHER SCHEDULE E INCOME Schedule K-1 D. A different Schedule K-1 is issued from each type of entity to report your share of income, deductions, credits, and losses to you. Shown on the next slide is a partner’s Schedule K-1.

98 98 OTHER SCHEDULE E INCOME

99 99 OTHER SCHEDULE E INCOME

100 100 OTHER SCHEDULE E INCOME

101 101 OTHER SCHEDULE E INCOME

102 102 Rental Real Estate, Royalties, Partnerships, etc. KEY IDEAS ♦ Report your rental income and your rental expenses on Schedule E. You are taxed on your net rental income which is the amount of rental income that exceeds your rental expenses. If your expenses exceed your income you may be able to deduct the loss from your other income such as your wages on Form 1040. ♦ If you use your rental property partly for personal purposes or change the use of your property from personal to rental, you must divide your expenses between the rental and personal use. ♦ The number of days you use a vacation home or other dwelling unit for personal purposes determines whether you use it as a home. If you use the unit as a home, you cannot deduct certain rental expenses to produce a loss.

103 103 Rental Real Estate, Royalties, Partnerships, etc. KEY IDEAS ♦ If your rental expenses exceed your income, your loss may be limited by at-risk and/or passive activity limits. If you actively participated in a passive rental real estate activity, you may be able to claim a loss of up to $25,000 depending on your modified AGI and filing status. If you are married, are filing a separate return and lived with your spouse at any time during the year, this special allowance is not available. ♦ You figure your net income or loss from rental real estate on Schedule E. Schedule E is also used to figure net income or loss from other sources of income including royalties and partnerships. ♦ Total net income or loss from rental real estate, royalty, partnership, and other sources is entered on line 17 of Form 1040.

104 104 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 1: True or False. (1) Percy charges $450 a month rent for the apartments he owns. His tenant Bud does minor repairs in the apartment building and shovels the driveway in the winter. In exchange Percy charges him only $350 a month. Percy must include $450 a month for Bud’s apartment in the rental income he reports on Schedule E. (2) On March 31, 2008, Bonita moved out of the home she had lived in for 4 years. She rented out the house until October 31, 2008 and sold it on November 1, 2008. The three months she lived in the house are not considered days of personal use when determining if the dwelling was used as a home. (3) Cornelia owns a house that she rents out. In 2008, she had to replace the furnace at a cost of $5,000. Cornelia can deduct the $5,000 as a rental expense.

105 105 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 1: True or False. (4) Kevin is a freelance writer. He will report the royalties he receives for his books in Part I of Schedule E. (5) Kelsey is married filing a separate return and he lived with his spouse for 9 months of 2008. Kelsey has a rental property in which he actively participates. He had a loss of $3,450 on the rental property and his AGI is $45,100. Kelsey can take the $3,450 loss on his 2008 tax return. (6) In 2008, Bill’s tenant failed to pay him three months rent amounting to $1,800. Bill can deduct this amount as a rental expense in 2008. (7) In most cases, if you actively participate in a rental real estate activity, you can deduct a loss of up to $25,000 a year from your non-rental income.

106 106 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 1: True or False. (8) Payment for cancellation of a lease is considered gross rent and is included in income in the year it is received. (9) Deke rented out his condominium in Florida for 270 days in 2008. He used the condo for 32 days. For 3 of those days he worked full time on painting the kitchen. Deke is considered to have used the condo as a home in 2008. (10) You can deduct your expenses for renting not-for-profit property on Schedule E up to the amount of your rental income. (11) Candace owns a residential rental property. In 2008, she spent $2,500 to put up a fence on the property. She can deduct the $2,500 on her 2008 tax return.

107 107 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 1: True or False. (12) The special loss allowance for a passive rental real estate activity is eliminated if your modified AGI is $150,000 or more ($75,000 or more if married filing a separate return and did not live with your spouse at any time during the year). (13) In 2008, Conner signed a three-year lease with Lincoln to rent a house that he owns for $700 per month. Conner received the first and last months rent at the time the lease was signed. Conner must include the $700 he received for the last month’s rent in his 2008 rental income. (14) Orin is single and his modified AGI is $42,000. In 2008, he owned 50% of an apartment building. He significantly participated in all management decisions relating to approving new tenants, deciding on rental terms, and approving expenditures. Orin’s loss from the rental property is $800. He can deduct that loss from his non- passive income.

108 108 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 1: True or False. (1) Percy charges $450 a month rent for the apartments he owns. His tenant Bud does minor repairs in the apartment building and shovels the driveway in the winter. In exchange Percy charges him only $350 a month. Percy must include $450 a month for Bud’s apartment in the rental income he reports on Schedule E. T (2) On March 31, 2008, Bonita moved out of the home she had lived in for 4 years. She rented out the house until October 31, 2008 and sold it on November 1, 2008. The three months she lived in the house are not considered days of personal use when determining if the dwelling was used as a home. T (3) Cornelia owns a house that she rents out. In 2008, she had to replace the furnace at a cost of $5,000. Cornelia can deduct the $5,000 as a rental expense. F

109 109 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 1: True or False. (4) Kevin is a freelance writer. He will report the royalties he receives for his books in Part I of Schedule E. F (5) Kelsey is married filing a separate return and he lived with his spouse for 9 months of 2008. Kelsey has a rental property in which he actively participates. He had a loss of $3,450 on the rental property and his AGI is $45,100. Kelsey can take the $3,450 loss on his 2008 tax return. F (6) In 2008, Bill’s tenant failed to pay him three months rent amounting to $1,800. Bill can deduct this amount as a rental expense in 2008. F (7) In most cases, if you actively participate in a rental real estate activity, you can deduct a loss of up to $25,000 a year from your non-rental income. T

110 110 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 1: True or False. (8) Payment for cancellation of a lease is considered gross rent and is included in income in the year it is received. T (9) Deke rented out his condominium in Florida for 270 days in 2008. He used the condo for 32 days. For 3 of those days he worked full time on painting the kitchen. Deke is considered to have used the condo as a home in 2008. T (10) You can deduct your expenses for renting not-for-profit property on Schedule E up to the amount of your rental income. F (11) Candace owns a residential rental property. In 2008, she spent $2,500 to put up a fence on the property. She can deduct the $2,500 on her 2008 tax return. F

111 111 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 1: True or False. (12) The special loss allowance for a passive rental real estate activity is eliminated if your modified AGI is $150,000 or more ($75,000 or more if married filing a separate return and did not live with your spouse at any time during the year). T (13) In 2008, Conner signed a three-year lease with Lincoln to rent a house that he owns for $700 per month. Conner received the first and last months rent at the time the lease was signed. Conner must include the $700 he received for the last month’s rent in his 2008 rental income. T (14) Orin is single and his modified AGI is $42,000. In 2008, he owned 50% of an apartment building. He significantly participated in all management decisions relating to approving new tenants, deciding on rental terms, and approving expenditures. Orin’s loss from the rental property is $800. He can deduct that loss from his non- passive income. T

112 112 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 2: Diane moved from her home in May 2008 and began advertising for a tenant on June 1, 2008. The house was available for rent but she did not rent it until July 1, 2008. Diane’s rental income for 2008 was $7,000. Her mortgage interest payments for the year totaled $3,800. Her real property tax was $2,100. She also paid $2,200 for her homeowner’s insurance policy and $800 for repairs and maintenance in November 2007. Diane’s AGI is $45,000 and she will file as single. Her depreciation for 2008 will be $1,330. Answer the following questions about Diane’s rental property:

113 113 Rental Real Estate, Royalties, Partnerships, etc. 1. How many months in 2008 was the house used for rental purposes? 2. What allocation of the expenses can Diane deduct on Schedule E? 3. What are Diane’s total rental expenses? 4. Which, if any, of these expenses can be reported elsewhere on her 2008 tax return and which allocation is being used?

114 114 Rental Real Estate, Royalties, Partnerships, etc. 1. How many months in 2008 was the house used for rental purposes? 7 months 2. What allocation of the expenses can Diane deduct on Schedule E? 7/12 3. What are Diane’s total rental expenses? $6,855 (7/12 of ($3,800, $2,100, $2,200) + $800+ $1,330) 4. Which, if any, of these expenses can be reported elsewhere on her 2008 tax return and which allocation is being used? Schedule A, mortgage interest and taxes (5/12 of $3,800, $2,100)

115 115 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 3: Determine whether the following costs for a rental house can be claimed as an expense (E) or as an item that must be depreciated (D): 1. purchase and installation of wall to wall carpeting 2. replacing a section of gutter that fell off 3. a new roof 4. patching a leak in the roof around the chimney 5. a new fence

116 116 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 3: Determine whether the following costs for a rental house can be claimed as an expense (E) or as an item that must be depreciated (D): 6. replacing the water pipes 7. a refrigerator 8. painting the house inside and out 9. adding a bathroom 10. putting in a new driveway

117 117 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 3: Determine whether the following costs for a rental house can be claimed as an expense (E) or as an item that must be depreciated (D): 1. purchase and installation of wall to wall carpeting Depreciated 2. replacing a section of gutter that fell off Expense 3. a new roof Depreciated 4. patching a leak in the roof around the chimney Expense 5. a new fence Depreciated

118 118 Rental Real Estate, Royalties, Partnerships, etc. CLASSWORK 3: Determine whether the following costs for a rental house can be claimed as an expense (E) or as an item that must be depreciated (D): 6. replacing the water pipes Depreciated 7. a refrigerator Depreciated 8. painting the house inside and out Expense 9. adding a bathroom Depreciated 10. putting in a new driveway Depreciated

119 119 Questions & Answers


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