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ferrarellaf
Level 1

Rental Property Taxation

Hello, I just started a rental operation. 

 

What are the obligations on the tax side? In other jurisdictions, there is a requirement for monthly remittances. 

 

Is the IRS requesting any of this? Any other requirements especially linked to payments before tax day?

 

Best Regards.

6 Replies
Carl
Level 15

Rental Property Taxation

@VolvoGirl has provided you some excellent resources to help you get self educated on this rental stuff. I especially recommend you familiarize yourself with IRS Publication 527.

Now with the TurboTax program, it's also important that you read the small print on each and every screen in the rental section, *before* you make selections or enter data. The small print does matter - otherwise the programmers would not have taken the time to put it there.

Now there are some things (I call them quirks) about the program, as some screens are worded in line with the statute that governs rental property. So it's easy for a first time landlord to interpret things in the wrong context if you're not careful.  To help with that, I've provided a bit of "clarification" that you may find helpful as your working through the Rental & Royalty Income (SCH E) section of the program for your very first time. But still, if you have questions, by all means ask. It's not like you learn this stuff through osmosis.

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.

 

ferrarellaf
Level 1

Rental Property Taxation

Thanks to both who replied.

 

This is great info for the general run of the rental operation - I need however to understand if the IRS is expecting some payment before tax filing day, on the rental income collected during the year.

 

Is the rental income going to be treated as other income, and therefore estimated taxes need to be somehow paid to avoid any underpayment penalties?

 

Thanks.

Carl
Level 15

Rental Property Taxation

Long term residential rental property produces passive income. If you have a mortgage on the property, your chances of actually showing a taxable profit are nil.

When you add up the deductible rental expenses of Mortgage interest, property taxes, insurance and add that to the depreciation you are required to take each year, the total of those four deductions alone will most likely exceed your total rental income for the entire tax year. Add to that the other allowed rental expenses (repairs, maintenance, etc.) and you're practically guaranteed to show a loss on paper, at tax filing time.

So don't worry about underpayment penalties. It's not gonna happen with your typical long term rental property. If you did have any underpayment penalties, I'm highly confident in stating that it won't be because of your passive rental income at all.

tagteam
Level 15

Rental Property Taxation


@ferrarellaf wrote:

I need however to understand if the IRS is expecting some payment before tax filing day, on the rental income collected during the year.


Your concern should be whether you will wind up with a penalty for underpayment of estimated tax.

 

See https://www.irs.gov/instructions/i2210#en_US_2021_publink1000305510

 

 

 

Who Must Pay the Underpayment Penalty

In general, you may owe the penalty for 2021 if the total of your withholding and timely estimated tax payments didn't equal at least the smaller of:

  1. 90% of your 2021 tax, or

  2. 100% of your 2020 tax. Your 2020 tax return must cover a 12-month period.

Higher income taxpayers.

If your adjusted gross income (AGI) for 2020 was more than $150,000 ($75,000 if your 2020 filing status was married filing separately), substitute 110% for 100% in (2) above.

Opus 17
Level 15

Rental Property Taxation


@ferrarellaf wrote:

Thanks to both who replied.

 

This is great info for the general run of the rental operation - I need however to understand if the IRS is expecting some payment before tax filing day, on the rental income collected during the year.

 

Is the rental income going to be treated as other income, and therefore estimated taxes need to be somehow paid to avoid any underpayment penalties?

 

Thanks.


The IRS is pay-as-you-go.  You can be penalized if you owe too much tax at the end of the year, even if you pay in full when you file.  Quarterly payments are due on the following schedule.

 

Income earned  payment due
Jan 1-Mar 31 Apr 15
Apr 1-May 31 June 15
June 1-Aug 31 Sept 15
Sept 1-Dec 31 Jan 15

 

(the quarters are not equal in length)

 

You can avoid a penalty by making estimated payments into the system, or by increasing your withholding from a regular job to cover the taxes from a side gig (including rentals).

 

Even though estimated payments are technically always owed, you won't be assessed an underpayment penalty if you meet one of three tests:

a. you owe less than $1000 when you file your return

b. your payments and withholding equal 90% or more of your current year tax liability

c. your payments and withholding equal 100% of last year's tax liability (or more than 110% of last year's liability for certain high income taxpayers)

 

Your tax liability is what you actually owe the government, regardless of payments or refunds.  For example, if you made payments and withholding of $10,000 and got a $1000 refund, then your tax liability was $9000.  Likewise, if your payments and withholding were $8000 and you owed an additional $1000 payment, your liability was $9000.

 

Also note that as per @Carl , rentals can sometimes generate positive cash flow but a tax loss on paper, so you might not actually have any taxable income that would require estimated payments (depending on your income, expenses, deprecation, and so on).

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
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