There could be many reasons you might have to rent out your second home or personal residence rather than selling it, which technically makes you a landlord in the books of the IRS and consequently subject to federal income taxes. So the big question you will face is what to do if you find yourself in the shoes of an accidental landlord.
Good news is that in the beginning most rental properties tend to generate taxable losses, which may result in tax savings for you. These savings are a result of deducting or shielding losses against some of your regular taxable income. But it is important to note that taxable losses are not the same as negative or positive cash flows and below we will highlight tips on doing your taxes as a new landlord.
Expenses and Income
When you file your taxes next year, you will be adding just one more form: Supplemental Income and Loss from Real Estate or IRS 1040 Form Schedule E. On this form, you will have to declare all the rental income you received the year before. After which you will have to enter all the expenses related to the property such as property taxes, mortgage interest gardening costs, maintenance repairs, HOA fees (these are now deducible because it is regarded as a rental property rather than a personal residence) and any other expenses.
The net rental income minus all the above expenses will generate a loss or income figure that will goes on Line 17 of the IRS1040 Schedule E form. Take for example, your rental income is $20,000 and your expenses are $25,000, you have a $5000 loss figure for tax purposes.
This is one of the better expenses that you can make against rental property, and in most cases is a large amount that can significantly reduce the amount of taxes you pay. To calculate this number, you first have to figure out the depreciable and tax basis of your rental property, which is mostly the price you initially paid for the property plus any capital enhancements made to the property in the last few years. So if you paid $300,000 for the home and you made improvements worth $50,000, your taxable basis figure is $350,000.
This basis is then divided into two components – building and land value, which is your depreciable basis amount. To determine your depreciable deduction to input just like any other expense in Schedule E, simply divide this value by 27.5 years. To avoid any mistakes in tax preparation, it is best to commission the services of a tax professional.
Putting it all Together
To understand how the income or loss reported on Schedule E is placed into your main 1040 form, simply take your net loss or income that you reported on your Schedule E form and transfer it to your 1040. A loss results in tax savings, while you will have to pay taxes when you report positive income. It is highly recommended that you speak to a tax professional and save all your receipts for maximum tax savings.