Deductions & credits

This post only covers dealing with this situation in your personal 1040 tax return. I'll cover entering it in the business tax return in a separate post in this thread.

First understand that all rental income and expenses is reported on SCH E. Period. Doesn’t matter if you’re reporting it on a 1040 personal return, 1065 partnership return or an 1120/1120-S corporate return. All rental income and expenses is reported on SCH E as a part of whatever type of return you are filing.

Start by getting it off the personal return. In this process there’s a lot of information you will need to write down as you go, because you will need that information when setting it up in the 1065, 1120 or 1120-S return. Regardless of what type of business return you’re filing, the transfer “process” is still the same.

On the personal 1040 return start by working through your rental “as if” nothing changed. You will work through and enter all rental income received and rental expenses incurred up to the date of the transfer. 

In the Property Profile section you must select the option for “I sold or otherwise disposed of this property in 2018.” When asked if the property was rented all year, you will say YES. It doesn’t matter if it sat empty for a month between renters. If you did not live in the property for one single day as your primary residence or second home in 2018, then it was rented all year.

In the Rental Income section you will report all rental income received before the date of the transfer. Doesn’t matter if you transferred on 6/30/2018 and they paid you a full year’s rent in advance prior to that date. You report every penny of that rental income received before the transfer date, regardless of what period(s) of time that income paid for.

In the Rental Expenses section you enter all rental expenses incurred and paid up to the date of the transfer. You will have to deal with three things that if not done correctly, you will be double-dipping on some deductible expenses and chances are you’ll raise flags at the IRS and get audited on it.  Those three things are mortgage interest, property taxes and property insurance. I’ll cover them in the order the program asks for those three expenses.

Insurance – You will have to pro-rate the insurance. What period of time in 2018 the insurance covers doesn’t matter, because it’s 12 months regardless of the start-stop dates of the currently active policy. So if you paid the policy premium for the year in Jan 2018 and the policy runs from March 1 2018 to Feb 28 2019 it doesn’t matter. If you transferred the property on Jun 30 2018, you will only enter 50% of the property insurance since the rental is owned by you personally for 50% of the year. Not 33% because the insurance premium you paid only covered the first 3 months of the policy.

Real Estate Taxes – The same rule applies here as above for insurance.

Mortgage Interest – You will pro-rate this the same as you pro-rated insurance and taxes.

Next is the “Sale of Property/Depreciation” section. If that section is named “Assets/Deprecation” then you need to go back through the Property Profile section and select the option for “I sold or otherwise disposed of this property in 2018.”

In the Sale of Assets/Deprecation section you must work through each individual asset one at a time to show it’s “disposition” on your personal tax return. Have pencil and paper handy because you will need to write down quite a bit of information on each asset, because when you enter it on the SCH E in the business program, things like the name of the asset need to match “exactly”.  The first asset listed (if you have more than one asset listed for this rental property) will be the property itself. Elect to edit it and let’s start working it through.

Write down “everything” on the Review information screen. You will need this information when you get to the business return. With one exception (covered below) everything must match “exactly” between the SCH E on the personal return, and the SCH E you’ll be completing on the business return.

Next screen is “Did you stop using this asset in 2018?”  Click the Yes button. Write down the “Date acquired” as you will enter this same exact date for this asset when you get to the business return. You need to enter the “date of sale or disposition” and this date needs to be one day “BEFORE” the business reports getting it. (Make “SURE” this date is the same for “ALL” assets, or you’ll have issues.)

Next screen is “Special Handling Required?”. Click YES on this screen.

Next screen is “Depreciation deduction amount” on this specific asset for tax year 2018. Write down this amount, as you will need it later when entering this asset on the SCH E in the business return.  Then click Continue.

You’re now back to the “Your Property Assets” summary screen. If you have other assets listed there, you must work through each individual asset just as you did the property asset, until you’ve got all the information I told you to write down for each individual asset. Once done, you can click the Done button on the “Your Property Assets” screen.

If you claimed “ANY” vehicle use/expenses on this rental then you must work through the Vehicle Expenses section and show the disposition of the vehicle. Basically, you’ll show the vehicle as “removed for personal use” and leave it at that, as I seriously doubt you transferred ownership of your vehicle to the business.

Now you can finish working through the rest of your personal 1040 tax return, but you can *NOT* file this return until "AFTER" you have completed the business return. This is because the business will be issuing you and your spouse each a K-1, which you will have to add to your personal return in order to file a "completed and accurate" personal return.