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If everything is just transferring to your sister's return - and I mean everything, all expenses and income - then you can just delete the schedule E from your return and she can put it on hers. As long as the income is reported you guys are good.
Everything would be reported on her return. Someone told me that it would be a red flag to just drop the schedule E and it might require me to "gift" the property to her or report the change to the IRS. I'm still on the title for the property. I just want her to fully manage things and get to keep the full income on it. Is there any reporting requirement if I stop having an income interest in the property?
No. Your friend is right that if you decide to gift her your half of the property then there is a reporting requirement. You - as the gift giver - are required to file a form detailing the gift and its value.
But for the rental property you two were already splitting it 50/50 on two returns and now it will be split 100/0. The IRS is expecting all of the income to be reported. You were never required to put it on 50/50. You could have said "my sister does more work than me" and split it 60/40 or 70/30 or whatever you guys deemed fair. As long as all of the income is reported then the IRS is happy. And in this case it is.
Thanks. Let me be sure I understand. I'm not planning to give her my portion of the house. I will continue to be on the title. If the property gets sold, we will divide the proceeds. It is the income generating agreement that has changed. She has been managing the property full-time for the last couple of years with little involvement from me. It is only fair that she get to keep the income and pay the expenses as the day-to-day manager (as you said going from 50/50 to 100/0). She will report the full income on her taxes, so to your point the IRS will have all income reported. I was planning to just stop including a schedule E for that property with my taxes.
Given this further clarification from me, am I fine just deleting the schedule E from my taxes and allowing her to report 100% on her taxes?
Yes. You do not have to report the income/expenses on your tax return as long as it is all reported on your sister's tax return. You can delete the schedule E from your return for 2022 and any year that you are not splitting the rental income.
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