Rental Property CPA tax accountant augments the Schedule E instructions | landlord tax issues

As a rental property CPA I re-read the IRS Schedule E instructions every year. However I mostly keep up with rental real estate tax reporting issues through a tax research database, and, publications, like Accounting Today and AICPA’s Journal of Accountancy. Much of my continuing professional education is on rental property issues. I think the 12 pages of Schedule E instructions cover a variety of rental property issues, so finding what pertains to the landlord’s particular Schedule E is hidden amidst strange terminology and technical writing. My favorite page of the Schedule E instructions? The last which cites an estimated hour and thirty-four minutes of tax preparation time for Schedule E.

IRS Schedule E, Supplemental Income and Loss, also covers Schedule K-1 from S Corporation Form 1120S and Partnerships, Form 1065. I’m just expanding on the rental property components in this post.

What the Schedule E instructions don’t cover:

Landlord Liability

• Your liability as a landlord is higher with Schedule E than with Form 8825 used with S Corporation Form 1120S and Partnerships Form 1065.
• A business entity, like an S Corporation, LLC or Partnership can prevent a lawsuit from attaching to the landlord’s personal assets.
  • You have to operate like an actual business entity or a lawyer can “pierce” the corporate veil despite a business entity.
  • So, don’t commingle funds, put insurance under your personal name, etc.
• An LLC also provides the extra layer of protection.
  • If you’re just a normal landlord, your SMLLC (Single Member LLC), you can still use Schedule E, or choose to be taxed as an S Corporation.
  • But with more than one landlord your LLC would be taxed as an S Corporation or Partnership.

Exit strategies not covered in the Schedule E instructions - S Corporation cancelled debt

I’m a rental property CPA because I have rental real estate in my extended family. But I’m also a cancelled debt CPA. And I’m getting lots of calls about rental property foreclosures and short sales for 2014. S Corporation cancelled debt income, from Form 1099-C, Cancellation of Debt, stays at the S Corporation level. It hits Form 1120-s but doesn’t channel down to the landlord on Schedule K-1. I handle S Corporation cancelled debt of course. Here’s a fun fact, the Form 1120-S instructions don’t even list line 11 of Schedule B where S Corporation cancelled debt gets reported. This exit contingency plan isn’t mentioned in the Schedule E instructions or the Form 1120S instructions.

How your rental property tax return will be audited

The IRS publishes their Audit Technique Guides that the Revenue Officers use as handbooks. There’s one on Passive Activities. If you don’t use a rental property CPA, I suggest landlords read it as part of due diligence.

Other IRS Forms you may need to file if you use Schedule E, Supplemental Income and Loss, to report your rental property

Here’s a list from the Schedule E instructions:

• Schedule A (Form 1040). For a mixed rental property e.g. where the landlord lives in the main house but rents out the guest apartment above the garage, the tax reporting for rental property requires allocating rental property expenses between Schedule E and Schedule A.
• Form 3520. The IRS has taken a harsh stance on foreign investment and investors.
• Form 4562 to claim depreciation. The Form 4562 instructions are awful. I only get through them because we did extensivedepreciationtraining in graduate school.
  • The IRS tracks depreciation carefully.
  • When you sell the rental real estate you have to “recapture” the depreciation taken, or that could have been taken.

“I think all rental property CPAs see cases where a landlord never claimed depreciation but still has to “recapture” it anyway when the rental property is sold. There’s a manual workaround when you sell. But the Schedule E instructions don’t explain the recapturing of un-claimed depreciation well.”
- Gary Bode, rental property CPA tax accountant

• Form 4684 to report a casualty or theft gain. Form 4684 channels down into Schedule A.
• Form 4797 to report business sales. The tax reporting rules for rental property sales, including foreclosures, aren’t rocket science. But the Form 4797 instructions make the Schedule E instructions read like a first grade primer.
  • I suggest doing the sale calculation manually to help ensure the tax software is calculating it correctly. It’s common to see sales double reported, under reported, etc.
• Form 6198. Most software handles Form 6198 automatically.
• Form 8082. Sometimes a landlord has an unusual property transaction. Your schedule E CPA explains your tax position on Form 8082.
• Form 8582 to figure your allowable loss from passive activities.

“I’ve seen self prepared Schedule E tax returns where all the previously disallowed passive losses from rental real estate aren’t deducted when the rental property is sold. That means losing, sometimes, enormous deductions. If you’re not using a Schedule E CPA use care when switching tax software.”
- Gary Bode, Schedule E CPA tax accountant

• Form 8824 to report like-kind exchanges. Here you need a Schedule E CPA. Both upon purchase and sale.
• Form 8826. The American Disabilities Act still allows deductions for making rental property handicap accessible.
• Form 8873. Not used often.
• Form 8910 to claim a credit for placing a new alternative motor vehicle in service for business use.
  • Rental property landlords can also own and therefore deduct a business vehicle.
• Form 8960. A new form for the pantheon of rental property tax reporting regulations.

How much rental real estate loss can I deduct?

Well for active landlord participation the Schedule E instructions answer is $25,000 a year. But that $25,000 phases out as your income increases. But with multiple properties that $25,000 limit can be higher because of previously disallowed losses. You can be active even if you have a property manager. All these calculations percolate through Form 8582. That $25,000 limit disappears if you’re a real estate professional. Schedule E instructions don’t cover the real estate professional guidelines well. Or at least there are lots of rental property tax court cases where a “professional” didn’t meet IRS standards.

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