Chapter 9 Rental Activities ©2007 CCH. All Rights Reserved West Peterson Ave. Chicago, IL CCH Essentials of Federal Income Taxation

2 of 15 Rental Income Rental income includes the payments taxpayers receive for allowing others to use or occupy their property. Chapter 9

CCH Essentials of Federal Income Taxation3 of 15 Rental Expenses Advertising Cleaning Maintenance Utilities Real estate taxes Mortgage interest Insurance premiums Management fees Necessary travel and transportation Repairs Depreciation Chapter 9

CCH Essentials of Federal Income Taxation4 of 15 Special Rules When Only Part of the Property Is Rented Sometimes the taxpayer rents only part of the property. When this is the case, Chapter 9 The taxpayer must allocate expenses between rental and personal use. The taxpayer then deducts the rental portion of each expense against rental income and can deduct the personal portion of the mortgage interest and real estate taxes as itemized deductions.

CCH Essentials of Federal Income Taxation5 of 15 Rental of Vacation Homes Property rented less than 15 days –rental income is not reported –no expenses may be deducted as rent expenses –home mortgage interest, real estate taxes, and casualty losses may be deducted Property rented more than 14 days –expenses related to the property must be allocated between rental and personal use Chapter 9

CCH Essentials of Federal Income Taxation6 of 15 What Is a Fair Rental Price? Are the properties used for the same purpose? Are the properties about the same size? Are the properties in about the same condition? Do the properties have similar features? Are the properties in similar locations? The following questions can be used to determine whether two properties are similar: Chapter 9

CCH Essentials of Federal Income Taxation7 of 15 Loss Limitations When rental expenses exceed rental income and the rental property is considered a “residence,” the vacation home rules limit the amount of rent expenses taxpayers can deduct against rental income. For rental property not subject to the vacation home limitation rules, two other sets of rules may affect the taxpayer’s ability to deduct losses arising from rental activities: the at-risk rules and the passive activity loss rules. Chapter 9

CCH Essentials of Federal Income Taxation8 of 15 At-Risk Rules The at-risk rules limit a taxpayer’s loss to the amount the taxpayer could actually lose from an activity. This is known as the amount the taxpayer is “at-risk.” Chapter 9

CCH Essentials of Federal Income Taxation9 of 15 Amounts at Risk A taxpayer’s risk in any activity equals the following: The money and adjusted basis (cost + improvements – accumulated depreciation) of any property contributed to the activity, plus Amounts borrowed for use in the activity if the taxpayer either is personally liable for the loan or pledges personal assets for the loan Chapter 9

CCH Essentials of Federal Income Taxation10 of 15 Passive Activity Losses Taxpayers can deduct passive activity losses only to the extent of passive activity income. Taxpayers carry over disallowed losses to offset passive income in future tax years. When the taxpayer disposes of the entire interest in a passive activity, any suspended losses left on that activity are fully deductible in that year. Chapter 9

CCH Essentials of Federal Income Taxation11 of 15 Definitions Portfolio income comes from investments that generate dividends, interest, and royalties. Active income consists of wages, salaries, and income from material participation in a trade or business. Passive income generally comes from: –a trade or business in which the taxpayer does not materially participate –rental activities –limited partnerships Material participation occurs when the taxpayer is involved in the operations of the activity on a regular, continuous, and substantial basis. Chapter 9

CCH Essentials of Federal Income Taxation12 of 15 Real Estate Trade or Business More than 50% of the personal services rendered during the year are performed in a trade or business involving real estate, and As a minimum, the taxpayer performs more than 750 hours of personal service in the real property trade or business A real estate rental activity may qualify as an active trade or business if: Chapter 9

CCH Essentials of Federal Income Taxation13 of 15 $25,000 Special Deduction for Active Participants The taxpayer actively participates in the rental real estate activity, and The taxpayer owns at least 10% of the value of all interests in the activity throughout the entire year To qualify for this special deduction, the taxpayer must meet both of the following requirements: Chapter 9

CCH Essentials of Federal Income Taxation14 of 15 Formula for Loss Allocation Process Loss from separate activity Total disallowed loss  Sum of all losses Chapter 9

CCH Essentials of Federal Income Taxation15 of 15 Dispositions of Passive Interests Taxpayers must give up their entire interest in the activity, There must be a transfer of ownership in a transaction where any realized gain or loss if fully recognized, and The new property owner cannot be the taxpayer’s sibling, ancestor, or descendent. Generally, when taxpayers dispose of their entire interest in a passive activity, any suspended losses relating to that activity are deductible in full. To qualify for this treatment: Chapter 9