by Mark A. Burns
These days, more and more people who wish to sell their home cannot sell it for the price they want and so they fall back on Plan B – renting it out. Common questions I am asked about this are, “Do I have to report the rent income on my tax return?” and “What expenses can I write off against the income?”
The answer to the first question is “yes.” All rent income must be included on Schedule E, Part I “Income or Loss from Rental Real Estate,” which gets attached to your Form 1040.
The following are examples of expenses that can be written off on Schedule E against rent income. (It is important to emphasize that these expenses only become rent expenses starting with the date the home becomes a rental property.)
- Mortgage interest and real estate taxes – These expenses are normally tax deductible anyway on your federal tax return; they just shift from Schedule A to Schedule E. But since Connecticut personal income tax is based on adjusted gross income, these expenses (and the others listed below) also help reduce your state tax liability.
- Any expenses incurred to help you find a tenant are deductible, e.g., advertising, commissions paid to a real estate agent, legal and professional fees, etc.
- All general operating expenses for the house, which previously were considered personal expenses, become tax deductible, including home insurance, maintenance and repairs, and any utilities you might pay.
- You also are allowed to take depreciation on your home as a tax deduction. This is generally calculated by taking the lesser of the current fair market value of the home or the total cost basis of the house (cost basis is generally original cost, excluding land that cannot be depreciated, plus improvements to the house over the years), and then dividing that amount by 27.5 years.
- Once you start renting your home, you are allowed to deduct travel expenses (including auto mileage) back to the home to inspect it, monitor activities, etc.
Now after all of the above expenses are included, most rental properties show a loss for tax purposes (i.e., expenses exceed income). By definition, according to IRS rules, a rental property is considered a “passive activity” and as a result, the amount of losses you are allowed to take each year may be limited and any excess may be carried over to future years.
As an additional comment, we do recommend you engage an attorney to prepare or review your lease for you before signing to help ensure you are fully protected if any issues arise with the tenant.
The above is a very general summary of what can be a very complicated subject. Each person’s particular situation can be unique. Always consult a tax professional if you are uncertain about how tax matters might affect you.
Mark A. Burns, M.B.A., is a C.P.A. with Diversified Financial Solutions PC in Southbury. He can be reached at 203-264-3131 or Mark@DFSPC.biz.
