Licensed Real Estate Agents:
Most real estate professionals operate their business as a sole proprietorship. This means that you are not someone’s employee, you haven’t formed a partnership with anyone, and you have not incorporated your business.
Licensed real estate agents are statutory nonemployees and are treated as self-employed for all Federal tax purposes, including income and employment taxes, if:
- Substantially all payments for their services as real estate agents are directly related to sales or other output, rather than to the number of hours worked
- Their services are performed under a written contract providing that they will not be treated as employees for Federal tax purposes
Sale of Residence:
You may qualify to exclude from your income all or part of any gain from the sale of your main home. Your main home is the one in which you live most of the time.
Ownership and Use Tests
To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:
- Owned the home for at least two years (the ownership test)
- Lived in the home as your main home for at least two years (the use test)
If you have a gain from the sale of your main home, you may be able to exclude up to $250,000 of the gain from your income ($500,000 on a joint return in most cases).
- If you can exclude all of the gain, you do not need to report the sale on your tax return
- If you have gain that cannot be excluded, it is taxable. Report it on Schedule D (Form 1040)
You cannot deduct a loss from the sale of your main home.
Reporting the Sale
Do not report the sale of your main home on your tax return unless:
- You have a gain and do not qualify to exclude all of it,
- You have a gain and choose not to exclude it, or
- You have a loss and received a Form 1099-S.
More Than One Home
If you have more than one home, you can exclude gain only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.
You own and live in a house in the city. You also own a beach house, which you use during the summer months. The house in the city is your main home; the beach house is not.
You own a house, but you live in another house that you rent. The rented house is your main home
Rental Income and Expenses:
You generally must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use or occupation of property.
Expenses of renting property can be deducted from your gross rental income. You generally deduct your rental expenses in the year you pay them.
When to Report Income
Report rental income on your return for the year you actually or constructively receive it, if you are a cash basis taxpayer. You are a cash basis taxpayer if you report income in the year you receive it, regardless of when it was earned. You constructively receive income when it is made available to you, for example, by being credited to your bank account.
Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use.
You sign a 10-year lease to rent your property. In the first year, you receive $5,000 for the first year’s rent and $5,000 as rent for the last year of the lease. You must include $10,000 in your income in the first year.
Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year.
If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Include it in your income when you receive it.
Expenses Paid by Tenant
If your tenant pays any of your expenses, the payments are rental income. You must include them in your income. You can deduct the expenses if they are deductible rental expenses.
Your tenant pays the water and sewage bill for your rental property and deducts it from the normal rent payment. Under the terms of the lease, your tenant does not have to pay this bill.
While you are out of town, the furnace in your rental property stops working. Your tenant pays for the necessary repairs and deducts the repair bill from the rent payment. Based on the facts in each example, include in your rental income both the net amount of the rent payment and the amount the tenant paid for the utility bills and the repairs. You can deduct the cost of the utility bills and repairs as a rental expense.
Property or Services in Lieu of Rent
If you receive property or services, instead of money, as rent, include the fair market value of the property or services in your rental income.
If the services are provided at an agreed upon or specified price, that price is the fair market value unless there is evidence to the contrary.
Your tenant is a painter. He offers to paint your rental property instead of paying 2 months’ rent. You accept his offer. Include in your rental income the amount the tenant would have paid for 2 months’ rent. You can include that same amount as a rental expense for painting your property.
Personal Use of Vacation Home or Dwelling Unit
If you have any personal use of a vacation home or other dwelling unit that you rent out, you must divide your expenses between rental use and personal use. If your expenses for rental use are more than your rental income, you may not be able to deduct all of the rental expenses.
Passive Activity Losses:
Generally, a passive activity is any rental activity OR any business in which the taxpayer does not materially participate. Non-passive activities are businesses in which the taxpayer works on a regular, continuous, and substantial basis. In addition, passive income does not include salaries, portfolio, or investment income.
As a general rule, the passive activity loss rules are applied at the individual level.
There Are Two Kinds of Passive Activities:
- Rentals, including both equipment and rental real estate, regardless of the level of participation
- Businesses in which the taxpayer does not materially participate on a regular, continuous, and substantial basis
Types of Income and Losses
Income and losses on a tax return are divided into two categories:
- Passive: Rentals and businesses without material participation. A limited partner is generally passive due to more restrictive tests for material participation. As a result, limited partners will generally have passive income or losses from the partnership
- Non-passive: Businesses in which the taxpayer materially participates. Also, salaries, guaranteed payments, 1099 commission income and portfolio or investment income are deemed to be non-passive. Portfolio income includes interest income, dividends, royalties, gains and losses on stocks, pensions, lottery winnings, and any other property held for investment
Income and losses from the following activities would generally be passive:
- Equipment leasing
- Rental real estate (with some exceptions)
- Sole proprietorship or farm in which the taxpayer does not materially participate
- Limited partnerships with some exceptions
- Partnerships, S-Corporations, and limited liability companies in which the taxpayer does not materially participate
Income and losses from the following activities would generally be non-passive:
- Salaries, wages, and 1099 commission income
- Guaranteed payments
- Interest and dividends
- Stocks and bonds
- Sale of undeveloped land or other investment property
- Royalties derived in the ordinary course of business
- Sole proprietorship or farm in which the taxpayer materially participates
- Partnerships, S-Corporations, and limited liability companies in which the taxpayer materially participates
- Trusts in which the fiduciary materially participates