How "Presumption of profit" works?

[anonymous8]

So, I have "not-for-profit rental".

In Pub 527 it's written:
 - "Report your not-for-profit rental income on Schedule 1 (Form 1040), line 21"
- "If your rental income is more than your rental expenses for at least 3 years out of a period of 5 consecutive years, you are presumed to be renting your property to make a profit."

In TT, to report "not-for-profit rental" I just add "Other taxable income", like this: "Not-For-Profit Rental - $X". I don't fill out the Schedule E, nor deduct any expenses, becasue I'm doing Standard Deduction. I can't deduct expenses becasue it's not for profit and therefore "personal property".

Anyway, how the IRS will know if my "rental" was profitable or not? It doesn't know if I had profit, It doesn't even know the address of the property to check if it's indeed under the market value. It doesn't know how many days was this property rented. I don't understand how "Presumption of profit" works.

[DanielV01 · Accepted solution]

It depends.  Your question is a good one.  The answer is not so much that the IRS knows that your rental is a "not for profit" activity, but rather that it would be easy for them to tell that it is not a "for profit" activity if you tried to report it as such.

Here's the idea:  the IRS may not know from you putting the income on line 21 that the rental income is not a fair-rental value for the dwelling you are renting.  However, if you were to report the rent you receive on Schedule E, and then the expenses, they could easily cross-reference the home with the Fair Rental Value on similar dwellings in your area and be able to tell immediately that you have a "not-for-profit" rental.

And, since you can't claim expenses (or QBI deduction either) against a not-for-profit rental on Line 21, it is extremely unlikely that they are going to question what is reported there.  (That doesn't mean that they can't question it, though).

A "for-profit" activity does not actually have to have a gain to be considered a "for-profit" activity, because, even at a fair rental value, there are a number of reasons a rental activity could produce repeated losses.  However, many of these losses are recaptured when the rental activity is eventually sold.  But if you are renting below fair rental value, you are correct in not reporting the rental on Schedule E but rather on Line 21, Schedule 1.

[anonymous8]

Did I understand correctly, that "Presumption of profit" matters mostly (almost only) for people who report actual rental property on Schedule E? I mean.. Technically by reporting "not-for-profit" rental, I'm losing money. "For-profit" rental would get me more money, so I guess it would be really strange if IRS would fight to get less money. Would you agree?

[DanielV01]

Because a "for-profit" rental can deduct expenses, a "not-for-profit" rental will get the IRS more money, because expenses cannot be deducted.  In years past, expenses could be deducted up to the amount of income, which could be claimed if the rental owner was itemizing on a not-for-profit rental.  But the Tax Cuts and Jobs Act did away with this deduction.  So it actually works out in the IRS' interests to question rentals that are not "for-profit" rentals so that the income must be included and taxed, whereas "for-profit" rentals are allowed to have expenses claimed.

[anonymous8]

Simply saying, IRS would rather classify a property as "not-for-profit" instead of "for-profit", correct?

[DanielV01]

I imagine this year more than others the IRS will be looking to re-classify questionable rentals because of the QBI deduction as much as anything, as well as the disallowed deductions.