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Julie Sturgeon: Rental-property tax rules are complicated

It's Your Money

Posted: August 18, 2010 3:47 p.m.
Updated: August 19, 2010 4:55 a.m.
 

These days, whether you’re an intentional landlord or an accidental one, you may have questions about how to report rental income and expenses. The rules are complex. Even the IRS admits it, saying errors related to rental-real estate activities contribute to what’s called the “tax gap,” a measure of tax-law compliance.

In general, all properties treated as rental properties are reported on a schedule E. On this schedule, you will report all of the rental income received, and then deduct all applicable expenses. The usual expenses are property taxes and mortgage interest. In addition, you may deduct your homeowner’s fees, insurance, gardening and other expenses to maintain and rent the property. Here are three areas where rental-property tax rules differ from what you might expect.

Depreciation
You’re probably familiar with immediate expensing rules, also called Section 179. Using these rules, you write off the cost of business assets in the year you purchase them. Section 179 is generally not available for residential rental property. Typically, you’ll depreciate residential rentals over 27.5 years. Appliances, carpeting and furniture are depreciated over five years.

Rental losses
When rental expenses exceed income, the loss may not be deductible on your current-year federal income tax return. Your income level and your participation in managing the property affect the deduction of any losses. Losses you are unable to use in the current year are “suspended.” Suspended losses can be applied against income from your rental in future years and/or can also reduce gain when you sell your property.

Sale of rental property
Depending on how you acquired your rental, the tax basis — the amount used to calculate gain or lose when you sell — may not be your cost. For example, if you used the property as your personal residence before renting it, your basis could be the fair market value of the home on the date you converted it to a rental instead of what you originally paid. Special rules may also apply if you made a former rental property your residence.

Vacation homes
A separate set of rules guide the deduction of vacation homes depending on how often you use your the home yourself, how often you rent it out and how long it sits empty. You will fall into one of three different tax categories.

The first category includes homes that are rented often but that are still used a fair amount by the owner. Specifically, this applies to homes that are rented more than 14 days a year and have personal use of more than 14 days. Personal use includes use by family members and anyone else who pays less than market rental rates. Interest, property taxes and operating expenses should all be allocated based on the total number of days the house was used.

The second vacation-home tax category typically applies to houses that are used very little by the owner. Your home will fall under the tax rules for rental properties just as we have discussed above.

The final category is simple and benefits the taxpayer. This one applies to homes that are rented for fewer than 15 days a year and used by the owner for more than 14 days. These homes are considered personal residences, so you simply deduct the interest and property taxes. The rent is not reported.

Timeshares
You can claim your share of property taxes (usually buried in the annual maintenance fee number) and mortgage interest as interest on a second home.

Julie M. Sturgeon is a certified public accountant in Valencia specializing in individual and business tax issues. Her column represents her own views and not necessarily those of The Signal. “It’s Your Money” appears Thursdays and rotates between a handful of the valley’s financial professionals.

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