Most of us regularly pay income taxes and majority claim the amount of standard deduction and file for a refund. However, it is not equally easy for those have a complex tax future in front of you. If you own a property that you have rented out, how do you deal with the rental income? You need to know how to treat the income and show it in your annual return.
Classification of the property
First and foremost, you need to classify the property and check whether it is a rental property or a personal residence which you rent out at times. There are different categories in the same.
Tax Free Rental
When you rent a property for a period of 14 days or less in one year, it will be a tax free rental. This is a break provided for short free rentals and you will not be required to make a claim of the income on taxes if you have rented it for current market rate. Also, it should be a property where you have lived for longer than 15 days.
When you make use of the property for more than 14 days or for a period which is more than 10% of the total days it had been rented, it will be considered as a personal residence. This property will not be a full rental property. Bob Kemble from https://clickandmortaraccounting.com explains that in order for a vacation home to classify as a rental property, you must use it for less than fourteen days in a year. Now if the family stays at the property for 15 days, the property will become personal residence. If you end up spending excess money than what you make on the property, you will not be able to deduct losses from the income as reported in IRS.
The property will be classified as a rental property if you rent it for more than 15 days and use it for a period of less than 14 days as a personal residence. This will be your rental property and you will have to report the income and deduct any expenses related to the property. Incase you make losses on the property, you will have to carry them on to the personal income.
Identify rental status
After the classification of the property, you will have to identify whether the rental will classify as passive activity or a non passive activity. As per IRS, most property rental is considered to be passive income. Non passive rental will mean that you are engaged in construction or property development at professional level. In case managing the property makes the most of your rental income, then you can easily qualify as a non passive property owner. If you make active decisions with regard to the property, you will be qualified as a passive owner. The losses cannot be deducted from the personal income but you can carry the losses forward to the coming year as a deduction on income generated from this property. As an active participant owning the property, it is possible to deduct losses from personal income up to a limit of $25,000. The loss which exceeds this cap will have to be carried over in the coming year and should be reported accordingly.
Expenses on mortgage property
A property owner can claim certain expenses from the income on the rented property. These expenses include the mortgage interest, insurance, property taxes, realtor commissions, travel expenses to and from the property, cleaning, repairs and maintenance, legal fees, depreciation, advertising expenses, utilities, decoration and necessary supplies. This list is not exhaustive. Basically, any money which is spent on owning and operating the rental property can be deducted from the property income.
If you are a property owner and if you rent it out during the year, it is important for you to be aware about the classification of the property and how to treat the rental income. You need to identify the expenses that are related to the property and you can claim them from your property income. Reporting of the correct income in your annual return is very important. This will also help reduce the amount of tax liability. When you report the income, you can claim the expenses and eventually bring down the liability of tax or make a claim for a refund on the amount of tax already paid by you.