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State ReturnsState returns 1. State returns Rental Income and Expenses (If No Personal Use of Dwelling) Table of Contents Rental IncomeWhen To Report Types of Income Rental ExpensesWhen To Deduct Types of Expenses This chapter discusses the various types of rental income and expenses for a residential rental activity with no personal use of the dwelling. State returns Generally, each year you will report all income and deduct all out-of-pocket expenses in full. State returns The deduction to recover the cost of your rental property—depreciation—is taken over a prescribed number of years, and is discussed in chapter 2, Depreciation of Rental Property. State returns If your rental income is from property you also use personally or rent to someone at less than a fair rental price, first read the information in chapter 5 , Personal Use of Dwelling Unit (Including Vacation Home). State returns Rental Income In most cases, you must include in your gross income all amounts you receive as rent. State returns Rental income is any payment you receive for the use or occupation of property. State returns In addition to amounts you receive as normal rental payments, there are other amounts that may be rental income. State returns When To Report When you report rental income on your tax return generally depends on whether you are a cash basis taxpayer or use an accrual method. State returns Most individual taxpayers use the cash method. State returns Cash method. State returns You are a cash basis taxpayer if you report income on your return in the year you actually or constructively receive it, regardless of when it was earned. State returns You constructively receive income when it is made available to you, for example, by being credited to your bank account. State returns Accrual method. State returns If you are an accrual basis taxpayer, you generally report income when you earn it, rather than when you receive it. State returns You generally deduct your expenses when you incur them, rather than when you pay them. State returns More information. State returns See Publication 538, Accounting Periods and Methods, for more information about when you constructively receive income and accrual methods of accounting. State returns Types of Income The following are common types of rental income. State returns Advance rent. State returns Advance rent is any amount you receive before the period that it covers. State returns Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use. State returns Example. State returns On March 18, 2013, you signed a 10-year lease to rent your property. State returns During 2013, you received $9,600 for the first year's rent and $9,600 as rent for the last year of the lease. State returns You must include $19,200 in your rental income in the first year. State returns Canceling a lease. State returns If your tenant pays you to cancel a lease, the amount you receive is rent. State returns Include the payment in your income in the year you receive it regardless of your method of accounting. State returns Expenses paid by tenant. State returns If your tenant pays any of your expenses, those payments are rental income. State returns Because you must include this amount in income, you can also deduct the expenses if they are deductible rental expenses. State returns For more information, see Rental Expenses , later. State returns Example 1. State returns Your tenant pays the water and sewage bill for your rental property and deducts the amount from the normal rent payment. State returns Under the terms of the lease, your tenant does not have to pay this bill. State returns Include the utility bill paid by the tenant and any amount received as a rent payment in your rental income. State returns You can deduct the utility payment made by your tenant as a rental expense. State returns Example 2. State returns While you are out of town, the furnace in your rental property stops working. State returns Your tenant pays for the necessary repairs and deducts the repair bill from the rent payment. State returns Include the repair bill paid by the tenant and any amount received as a rent payment in your rental income. State returns You can deduct the repair payment made by your tenant as a rental expense. State returns Property or services. State returns If you receive property or services as rent, instead of money, include the fair market value of the property or services in your rental income. State returns If the services are provided at an agreed upon or specified price, that price is the fair market value unless there is evidence to the contrary. State returns Example. State returns Your tenant is a house painter. State returns He offers to paint your rental property instead of paying 2 months rent. State returns You accept his offer. State returns Include in your rental income the amount the tenant would have paid for 2 months rent. State returns You can deduct that same amount as a rental expense for painting your property. State returns Security deposits. State returns Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. State returns But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year. State returns If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. State returns Include it in your income when you receive it. State returns Other Sources of Rental Income Lease with option to buy. State returns If the rental agreement gives your tenant the right to buy your rental property, the payments you receive under the agreement are generally rental income. State returns If your tenant exercises the right to buy the property, the payments you receive for the period after the date of sale are considered part of the selling price. State returns Part interest. State returns If you own a part interest in rental property, you must report your part of the rental income from the property. State returns Rental of property also used as your home. State returns If you rent property that you also use as your home and you rent it less than 15 days during the tax year, do not include the rent you receive in your income and do not deduct rental expenses. State returns However, you can deduct on Schedule A (Form 1040), Itemized Deductions, the interest, taxes, and casualty and theft losses that are allowed for nonrental property. State returns See chapter 5, Personal Use of Dwelling Unit (Including Vacation Home). State returns Rental Expenses In most cases, the expenses of renting your property, such as maintenance, insurance, taxes, and interest, can be deducted from your rental income. State returns Personal use of rental property. State returns If you sometimes use your rental property for personal purposes, you must divide your expenses between rental and personal use. State returns Also, your rental expense deductions may be limited. State returns See chapter 5, Personal Use of Dwelling Unit (Including Vacation Home). State returns Part interest. State returns If you own a part interest in rental property, you can deduct expenses you paid according to your percentage of ownership. State returns Example. State returns Roger owns a one-half undivided interest in a rental house. State returns Last year he paid $968 for necessary repairs on the property. State returns Roger can deduct $484 (50% × $968) as a rental expense. State returns He is entitled to reimbursement for the remaining half from the co-owner. State returns When To Deduct You generally deduct your rental expenses in the year you pay them. State returns If you use the accrual method, see Publication 538 for more information. State returns Types of Expenses Listed below are the most common rental expenses. State returns Advertising. State returns Auto and travel expenses. State returns Cleaning and maintenance. State returns Commissions. State returns Depreciation. State returns Insurance. State returns Interest (other). State returns Legal and other professional fees. State returns Local transportation expenses. State returns Management fees. State returns Mortgage interest paid to banks, etc. State returns Points. State returns Rental payments. State returns Repairs. State returns Taxes. State returns Utilities. State returns Some of these expenses, as well as other less common ones, are discussed below. State returns Depreciation. State returns Depreciation is a capital expense. State returns It is the mechanism for recovering your cost in an income producing property and must be taken over the expected life of the property. State returns You can begin to depreciate rental property when it is ready and available for rent. State returns See Placed in Service under When Does Depreciation Begin and End in chapter 2. State returns Insurance premiums paid in advance. State returns If you pay an insurance premium for more than one year in advance, for each year of coverage you can deduct the part of the premium payment that will apply to that year. State returns You cannot deduct the total premium in the year you pay it. State returns See chapter 6 of Publication 535 for information on deductible premiums. State returns Interest expense. State returns You can deduct mortgage interest you pay on your rental property. State returns When you refinance a rental property for more than the previous outstanding balance, the portion of the interest allocable to loan proceeds not related to rental use generally cannot be deducted as a rental expense. State returns Chapter 4 of Publication 535 explains mortgage interest in detail. State returns Expenses paid to obtain a mortgage. State returns Certain expenses you pay to obtain a mortgage on your rental property cannot be deducted as interest. State returns These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses that are part of your basis in the property. State returns Form 1098, Mortgage Interest Statement. State returns If you paid $600 or more of mortgage interest on your rental property to any one person, you should receive a Form 1098 or similar statement showing the interest you paid for the year. State returns If you and at least one other person (other than your spouse if you file a joint return) were liable for, and paid interest on, the mortgage, and the other person received the Form 1098, report your share of the interest on Schedule E (Form 1040), line 13. State returns Attach a statement to your return showing the name and address of the other person. State returns On the dotted line next to line 13, enter “See attached. State returns ” Legal and other professional fees. State returns You can deduct, as a rental expense, legal and other professional expenses such as tax return preparation fees you paid to prepare Schedule E, Part I. State returns For example, on your 2013 Schedule E you can deduct fees paid in 2013 to prepare Part I of your 2012 Schedule E. State returns You can also deduct, as a rental expense, any expense (other than federal taxes and penalties) you paid to resolve a tax underpayment related to your rental activities. State returns Local benefit taxes. State returns In most cases, you cannot deduct charges for local benefits that increase the value of your property, such as charges for putting in streets, sidewalks, or water and sewer systems. State returns These charges are nondepreciable capital expenditures and must be added to the basis of your property. State returns However, you can deduct local benefit taxes that are for maintaining, repairing, or paying interest charges for the benefits. State returns Local transportation expenses. State returns You may be able to deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property. State returns However, transportation expenses incurred to travel between your home and a rental property generally constitute nondeductible commuting costs unless you use your home as your principal place of business. State returns See Publication 587, Business Use of Your Home, for information on determining if your home office qualifies as a principal place of business. State returns Generally, if you use your personal car, pickup truck, or light van for rental activities, you can deduct the expenses using one of two methods: actual expenses or the standard mileage rate. State returns For 2013, the standard mileage rate for business use is 56. State returns 5 cents per mile. State returns For more information, see chapter 4 of Publication 463. State returns To deduct car expenses under either method, you must keep records that follow the rules in chapter 5 of Publication 463. State returns In addition, you must complete Form 4562, Part V, and attach it to your tax return. State returns Pre-rental expenses. State returns You can deduct your ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available for rent. State returns Rental of equipment. State returns You can deduct the rent you pay for equipment that you use for rental purposes. State returns However, in some cases, lease contracts are actually purchase contracts. State returns If so, you cannot deduct these payments. State returns You can recover the cost of purchased equipment through depreciation. State returns Rental of property. State returns You can deduct the rent you pay for property that you use for rental purposes. State returns If you buy a leasehold for rental purposes, you can deduct an equal part of the cost each year over the term of the lease. State returns Travel expenses. State returns You can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip is to collect rental income or to manage, conserve, or maintain your rental property. State returns You must properly allocate your expenses between rental and nonrental activities. State returns You cannot deduct the cost of traveling away from home if the primary purpose of the trip is to improve the property. State returns The cost of improvements is recovered by taking depreciation. State returns For information on travel expenses, see chapter 1 of Publication 463. State returns To deduct travel expenses, you must keep records that follow the rules in chapter 5 of Publication 463. State returns Uncollected rent. State returns If you are a cash basis taxpayer, do not deduct uncollected rent. State returns Because you have not included it in your income, it is not deductible. State returns If you use an accrual method, report income when you earn it. State returns If you are unable to collect the rent, you may be able to deduct it as a business bad debt. State returns See chapter 10 of Publication 535 for more information about business bad debts. State returns Vacant rental property. State returns If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining the property while the property is vacant. State returns However, you cannot deduct any loss of rental income for the period the property is vacant. State returns Vacant while listed for sale. State returns If you sell property you held for rental purposes, you can deduct the ordinary and necessary expenses for managing, conserving, or maintaining the property until it is sold. State returns If the property is not held out and available for rent while listed for sale, the expenses are not deductible rental expenses. State returns Points The term “points” is often used to describe some of the charges paid, or treated as paid, by a borrower to take out a loan or a mortgage. State returns These charges are also called loan origination fees, maximum loan charges, or premium charges. State returns Any of these charges (points) that are solely for the use of money are interest. State returns Because points are prepaid interest, you generally cannot deduct the full amount in the year paid, but must deduct the interest over the term of the loan. State returns The method used to figure the amount of points you can deduct each year follows the original issue discount (OID) rules. State returns In this case, points are equivalent to OID, which is the difference between: The amount borrowed (redemption price at maturity, or principal) and The proceeds (issue price). State returns The first step is to determine whether your total OID (which you may have on bonds or other investments in addition to the mortgage loan), including the OID resulting from the points, is insignificant or de minimis. State returns If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct. State returns De minimis OID. State returns The OID is de minimis if it is less than one-fourth of 1% (. State returns 0025) of the stated redemption price at maturity (principal amount of the loan) multiplied by the number of full years from the date of original issue to maturity (term of the loan). State returns If the OID is de minimis, you can choose one of the following ways to figure the amount of points you can deduct each year. State returns On a constant-yield basis over the term of the loan. State returns On a straight line basis over the term of the loan. State returns In proportion to stated interest payments. State returns In its entirety at maturity of the loan. State returns You make this choice by deducting the OID (points) in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued. State returns Example. State returns Carol Madison took out a $100,000 mortgage loan on January 1, 2013, to buy a house she will use as a rental during 2013. State returns The loan is to be repaid over 30 years. State returns During 2013, Carol paid $10,000 of mortgage interest (stated interest) to the lender. State returns When the loan was made, she paid $1,500 in points to the lender. State returns The points reduced the principal amount of the loan from $100,000 to $98,500, resulting in $1,500 of OID. State returns Carol determines that the points (OID) she paid are de minimis based on the following computation. State returns Redemption price at maturity (principal amount of the loan) $100,000 Multiplied by: The term of the loan in complete years ×30 Multiplied by ×. State returns 0025 De minimis amount $7,500 The points (OID) she paid ($1,500) are less than the de minimis amount ($7,500). State returns Therefore, Carol has de minimis OID and she can choose one of the four ways discussed earlier to figure the amount she can deduct each year. State returns Under the straight line method, she can deduct $50 each year for 30 years. State returns Constant-yield method. State returns If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. State returns You figure your deduction for the first year in the following manner. State returns Determine the issue price of the loan. State returns If you paid points on the loan, the issue price generally is the difference between the principal and the points. State returns Multiply the result in (1) by the yield to maturity (defined later). State returns Subtract any qualified stated interest payments (defined later) from the result in (2). State returns This is the OID you can deduct in the first year. State returns Yield to maturity (YTM). State returns This rate is generally shown in the literature you receive from your lender. State returns If you do not have this information, consult your lender or tax advisor. State returns In general, the YTM is the discount rate that, when used in computing the present value of all principal and interest payments, produces an amount equal to the principal amount of the loan. State returns Qualified stated interest (QSI). State returns In general, this is the stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a fixed rate. State returns Example—Year 1. State returns The facts are the same as in the previous example. State returns The yield to maturity on Carol's loan is 10. State returns 2467%, compounded annually. State returns She figured the amount of points (OID) she could deduct in 2013 as follows. State returns Principal amount of the loan $100,000 Minus: Points (OID) –1,500 Issue price of the loan $98,500 Multiplied by: YTM × . State returns 102467 Total 10,093 Minus: QSI –10,000 Points (OID) deductible in 2013 $93 To figure your deduction in any subsequent year, you start with the adjusted issue price. State returns To get the adjusted issue price, add to the issue price figured in Year 1 any OID previously deducted. State returns Then follow steps (2) and (3), earlier. State returns Example—Year 2. State returns Carol figured the deduction for 2014 as follows. State returns Issue price $98,500 Plus: Points (OID) deducted in 2013 +93 Adjusted issue price $98,593 Multiplied by: YTM × . State returns 102467 Total 10,103 Minus: QSI –10,000 Points (OID) deductible in 2014 $103 Loan or mortgage ends. State returns If your loan or mortgage ends, you may be able to deduct any remaining points (OID) in the tax year in which the loan or mortgage ends. State returns A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. State returns However, if the refinancing is with the same lender, the remaining points (OID) generally are not deductible in the year in which the refinancing occurs, but may be deductible over the term of the new mortgage or loan. State returns Points when loan refinance is more than the previous outstanding balance. State returns When you refinance a rental property for more than the previous outstanding balance, the portion of the points allocable to loan proceeds not related to rental use generally cannot be deducted as a rental expense. State returns For example, if an individual refinanced a loan with a balance of $100,000, the amount of the new loan was $120,000, and the taxpayer used $20,000 to purchase a car, points allocable to the $20,000 would be treated as nondeductible personal interest. State returns Repairs and Improvements Generally, an expense for repairing or maintaining your rental property may be deducted if you are not required to capitalize the expense. State returns Improvements. State returns You must capitalize any expense you pay to improve your rental property. State returns An expense is for an improvement if it results in a betterment to your property, restores your property, or adapts your property to a new or different use. State returns Betterments. State returns Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property. State returns Restoration. State returns Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition. State returns Adaptation. State returns Expenses that may be for adaptation include expenses for altering your property to a use that is not consistent with the intended ordinary use of your property when you began renting the property. State returns Separate the costs of repairs and improvements, and keep accurate records. State returns You will need to know the cost of improvements when you sell or depreciate your property. State returns The expenses you capitalize for improving your property can generally be depreciated as if the improvement were separate property. State returns Table 1-1. State returns Examples of Improvements Additions Bedroom Bathroom Deck Garage Porch Patio Lawn & Grounds Landscaping Driveway Walkway Fence Retaining wall Sprinkler system Swimming pool Miscellaneous Storm windows, doors New roof Central vacuum Wiring upgrades Satellite dish Security system Heating & Air Conditioning Heating system Central air conditioning Furnace Duct work Central humidifier Filtration system Plumbing Septic system Water heater Soft water system Filtration system Interior Improvements Built-in appliances Kitchen modernization Flooring Wall-to-wall carpeting Insulation Attic Walls, floor Pipes, duct work Prev Up Next Home More Online Publications
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