Most U.S. citizens have a genuine fear of the IRS. To avoid being audited, it is crucial that all rental income and sales profits are reported accurately to the IRS. The profits you earn from selling a rental property are just as important as the rental income you collect from renting out your property. Depending on whether you used the property solely for profit, or if the property was used for both business and personal uses, there are different ways the sale is reported to the IRS. Consult an attorney or accountant if needed.
Determine the Type of Accounting Method to Use
Decide whether you want to use the cash method or the accrual method to report your income. If you decided to use the cash method, you will claim the income you actually receive in that tax year. If you choose to use the accrual method, the IRS requires that you report the income in the tax year it is earned. Most tax payers use the cash method.
List your income. Compile a complete list of all the income you received that tax year if you choose to use the cash method to report your income to the IRS. Or, compile a complete list of all the income that you earned in that tax year if you choose to report your income to the IRS using the accrual method.
Calculate the number of days throughout the year that the rental property was used for fair rental days and personal use days. Enter the number of days in the corresponding columns on the Schedule E, line 1b, row A.
Calculate Rental Income
Separate and calculate the income you received or earned according to the type and source of the income received. Types of income include advanced rent payments, security deposits, fees charged for canceling a lease, expenses paid by tenant, property or services received in lieu of rent payments and payments received under a lease with option to buy agreement.
Calculate your total rental expenses related to that property for the current tax year. Maintenance fees, insurance premiums paid, taxes and interest paid are some of the expenses that the IRS may allow you to deduct from your rental income.
Insert your rental expenses on the Schedule E on the designated lines.
Determine if your property can be depreciated based on the activity use of the property using the rules as indicated in IRS Publication 527.
Determine your basis in the property. The basis used for the purpose of depreciation is calculated using your cost of acquiring the property adjusted by specific deductions and improvements approved by the IRS, as explained in Publication 527. Your closing documents, or settlement statement, should list your costs of acquiring the property.
Choose which depreciation method you will use. Most taxpayers use the MACRS method. The MACRS depreciation method is used for properties placed in service after 1986. The ACRS method is used for properties placed before 1986, but after 1981.
Determine the recovery period allowed by the IRS, which is determined by the depreciation method used and the property class.
Figure and report your calculated depreciation. Complete IRS Form 4562, Section III, and transfer the amount on Line 22 over to line 18 on your Schedule E.
Report Rental Income
Select the proper form. Determine which form you need to use to properly report the income earned on your property. Schedule E is the basic form used to report rental income and expenses for profit earning activity, without any personal use of the property. Schedule A is used if the rental property was used for not-for-profit activities, or used for profit, but the property was also used for personal use. Schedule C is used if you are a real estate dealer and the property was used for business purposes.
Complete Part I of the Schedule E if your property was used to generate profit only, without personal use for your own. List your total income on line 3, and your depreciation allowance from Form 4562 on to Line 18. Itemize your expenses in Part 1 of the Schedule E on lines 5 thru 19.
Complete the Personal Use Worksheet 5.1 found in IRS Publication 527, and transfer the appropriate numbers from the worksheet over to line 13 on the Schedule A if your property qualifies due to non-for-profit use or it was used as a combination of both personal and rental use.
Transfer the appropriate numbers from the Schedule A and Schedule E over to the corresponding lines on the IRS 1040 form.
Items you will need
- IRS Schedule E
- IRS Publication 527
- Closing Documents from Sale
- IRS Form 4562
- IRS Schedule A
- IRS Schedule C
- IRS Form 1040
- If you accelerated your depreciation, you may be subject to AMT. Use the Instructions for IRS Form 6251 to determine the affect of accelerating your depreciation.
- If you used your rental property for personal and rental uses combined, there are personal use adjustments that must be made to ensure the income, expenses and deductions are divided accurately. Use Publication 527 to determine is adjustment is needed.
- Special activity use such as condominiums, cooperatives and when only a part of the property is rented out may require additional IRS forms. Use Publication 527 to determine if any additional information or documents are required for IRS Rental income reporting.
- Be careful not to include personal use deductions and expenses with rental use, and vice versa.
- If you depreciate you property under the MACRS method, there are certain deductions and credits that may reduce your basis in the property.
- Consult an attorney or accountant if necessary.
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