This is my first time filing taxes since we converted our home into a rental property, and some of the instructions are confusing to me.
There are some things in the program that, in my personal opinion don't provide the clarity I think they should. I've added information at the end of my post that will help clarify some of the more common things where I think needed clarity in the software is lacking.
As you work through the SCH E section of the program, you will be presented with somwhere around 10 different expense categories. Should be pretty simple really. But if you question an actual expense that you paid, by all means you can seek clarification here.
Do we still count as "Active Participants" even though the property management company handles the tenant application / approval process and all small (<$500) repairs / maintenance without our input?
No. IRS Publication 527 at https://www.irs.gov/pub/irs-pdf/p527.pdf clarifies on page 13 of that document:
Active participation. You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions.
How do I know what expenses I should be including as deductions?
If *YOU* pay the expense, then you can deduct it. If the manager pays the expense and then bills you for it, (and you actually pay the bill) that's the same as if you paid the expense directly. If this is a case of where the manager withholds the expense from the rental income they pay to you, then you can't deduct it.
When entering real estate taxes paid on the property, should I just put the total amount shown on the 1098 we received?
Enter the 1098 exactly as printed. Your real estate taxes are deductible in the tax year they are paid, regardless of what year those taxes pay "for".
When entering the mortgage interest, it's asking me to check a box indicating either Qualified or Non-Qualified Interest
Plan and simple, it's qualified interest. Unqualified interest would be interest paid on the loan or any portion thereof, for loan proceeds that were not used to buy, build, or improve the property.
Do I need to divide the total interest paid (as listed on the 1098) into two portions to represent both individually?
Yes. Interest paid for the period of time it was "NOT" classified as a rental is a SCH A itemized deduction. Interest paid for the period of time it "WAS" classified as a rental, is a SCH E deduction. It depends on your specific selections as you started entering the property for the first time, as to weather or not the program (not you) will do the splits between SCH E and SCH A for you.
If so, does the Qualified Interest automatically reflect under my personal deductions and credits?
Only if it's qualified interest. Since it was your primary residence prior, it's qualified interest.
I didn't enter anything for Qualified Mortgage Insurance, because I was confused by the Qualified vs Non-Qualified. How would I handle this field?
Nothing special. If you have an amount in box 5 of your 1098, enter it accordingly. If you manually split box 1 between SCH A and SCH E, then you'll need to split box 5 the same.
Now here's that additional information I referenced at the start of my post. Note that absolute perfection in your first year with rental property is not an option.... its a must. Even the tiniest of mistakes can (and will) grow exponentially over the years. Then when you catch the error later down the road (usually the year you sell the property) the cost of fixing it *will* be expense. So if you have more questions as you work through through, by all means please asks. Asking questions on this forum costs nothing. Fixing mistakes later in life can be costly.
Rental Property Dates & Numbers That Matter.
Date of Conversion - If this was your primary residence or 2nd home before, then this date is the day AFTER you moved out, or the date you decided to lease the property – whichever is later.
In Service Date - This is the date a renter "could" have moved in. Usually, this date is the day you put the FOR RENT sign in the front yard.
Number of days Rented - the day count for this starts from the first day a renter was contracted to move in, and/or "could" have moved in. That would be your "in service" date or after if you were asked for that. Vacant periods between renters do not count for actual days rented. Please see IRS Publication927 page 17 at https://www.irs.gov/pub/irs-pdf/p527.pdf#en_US_2020_publink1000219175 Read the “Example” in the third column.
Days of Personal Use - This number will be a big fat ZERO. Read the screen. It's asking for the number of days *YOU* lived in the property AFTER you converted it to a rental. I seriously doubt (though it is possible) that you lived in the house (or space, if renting a part of your home) as your primary residence, 2nd home, or any other personal use reasons after you converted it to a rental.
Business Use Percentage. 100%. I'll put that in words so there's no doubt I didn't make a typo here. One Hundred Percent. After you converted this property or space to rental use, it was one hundred percent business use. What you used it for prior to the date of conversion doesn't count.
RENTAL PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED
Property Improvement.
Property improvements are expenses you incur that Improve, restore, or otherwise “better” the property. Basically, they retain or add value to the property.
Betterments:
Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property. An example of a pre-existing condition or defect in this context would be something such as foundation repair (slab jacking) or some other, hidden and costly, anomaly.
Restoration:
Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition.
Adaptation:
Expenses that may be for adaptation include expenses for altering your property to a use that isn’t consistent with the intended ordinary use of your property when you began renting the property. Adding a wheelchair ramp would be an example.
Expenses for these types of costs are entered in the Assets/Depreciation section and depreciated over time. Property improvements can be done at any time after your initial purchase of the property. It does not matter if it was your residence or a rental at the time of the improvement. It still adds value to the property.
To be classified as a property improvement, two criteria need to be met:
1) The improvement must become "a material part of" the property. For example, remodeling the bathroom, new cabinets or appliances in the kitchen. New carpet. Replacing that old Central Air unit.
2) The improvement must retain or add "real" value to the property. In other words, when the property is appraised by a qualified, certified, licensed property appraiser, he will appraise it at a higher value, than he would have without the improvements.
There are rules that allow you to just flat-out expense and deduct some property improvements instead of capitalizing and depreciating them, if the total cost of the improvement was less than $2,500. It’s referred to as “safe harbor di-minimis” But depending on the specific situation, this may or may not be beneficial. Just be aware that not every property improvement that cost less than $2,500 qualifies for this. If this interest you, the rules can get complex. So a good place to start reading is on the IRS website at https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations. The stuff on di-minimis starts about one page down.
Cleaning & Maintenance
Those expenses incurred to maintain the rental property and its assets in the usable condition the property and/or asset was designed and intended for. Routine cleaning and maintenance expenses are only deductible if they are incurred while the property is classified as a rental. Cleaning and maintenance expenses incurred in the process of preparing the property for rent for the very first time are not deductible.
Repair
Those expenses incurred to return the property or its assets to the same usable condition they were in, prior to the event that caused the property or asset to be unusable. Repair expenses incurred are only deductible if incurred while the property is classified as a rental. Repair costs incurred in the process of preparing the property for rent for the very first time are not deductible.
Additional clarifications: Painting a room does not qualify as a property improvement. While the paint does become “a material part of” the property, from the perspective of a property appraiser, it doesn’t add “real value” to the property.
However, when you do something like convert the garage into a 3rd bedroom for example, making a 2-bedroom house into a 3-bedroom house adds “real value”. Of course, when you convert the garage to a bedroom, you’re going to paint it. But you will include the cost of painting as a part of the property improvement – not an expense separate from it.
