Taxpayer Rental Activities of Real Estate
A taxpayer reports rental activity operations from real estate on Schedule E. Similar to Schedule C, the taxpayer reports their gross rents from the operations as well as deductions related to the rental activity. A list of common expenses can be found on the Schedule E form.
A taxpayer is also entitled to depreciation deductions for the "exhaustion, wear and tear" of income-producing property (i.e., the home rented). See I.R.C. Sec. 167(a)(2). The taxpayer must depreciate the residential real property using the straight-line method of depreciation over a period of 27.5 years. See I.R.C. Sec. 168(b)(3) and Sec. 168(c). Additionally, the taxpayer must use the mid-month convention whihc provides that property "placed in service during any month (or disposed of during any month)" is treated as place in service for purposes of hte depreciation calculation in the mid-point of that month. I.R.C. Sec. 168(d)(2); Sec. 168(d)(4)(B). The Internal Revenue Code defines a "residential rental property" as one where 80 % or more of gross rentals are derived from rental income from a home or apartment used to provide living accomodations (excluding hotels, motels, etc that are used in a transient manner). I.R.C. Sec. 168(e)(2). Depreciation deductions, insurance premiums, and real estate taxes are often times significant and should not be overlooked.
Residential rental property is what is referred to in the Code as Section 1250 property. See I.R.C. Sec. 1250(c). When a taxpayer disposes of Section 1250 property, special taxation rates apply. Normally, absent Section 1250, a taxpayer's sale of a rental home would result in entirely capital gain treatment (currently, a preferential rate of 15 %). However, Section 1250 property dispositions or sales require the taxpayer to essentially treat the depreciation deductions taken as ordinary income subject to a 25 % tax rate. If there is any excess over the deductions taken, the remaining balance is treated as a capital gain.
Example: Alice has one rental home in New Jersey. Alice's adjusted basis in the home was $100,000. After 7 years of renting the home, and taking $25,000 in depreciation deductions, Alice decides to sell the home to Homer for $150,000. Alice's amount realized is $75,000 [the $150,000 Alice received as the sales price minus her current adjusted basis of $75,000]. Because Alice has taken $25,000 in depreciation deductions, $25,000 of the gain will be Section 1250 gain and taxed at 25 % (tax practioners refer to the $25,000 amount as "depreciation recapture"). The remaining $50,000 will be taxed as a capital gain (currently 15 %).
A word of caution here about depreciation deductions. I.R.C. Section 1250 refers to the depreciation recaputure amount as the amount of depreciation allowed or allowable. See I.R.C. Sec. 1250(b)(3). Thus, if you decide you do not want to take the depreciation deductions (maybe out of fear that you do not want to have Section 1250 gain later), the Code treats it as if you took the deductions anyway!
A taxpayer is also entitled to depreciation deductions for the "exhaustion, wear and tear" of income-producing property (i.e., the home rented). See I.R.C. Sec. 167(a)(2). The taxpayer must depreciate the residential real property using the straight-line method of depreciation over a period of 27.5 years. See I.R.C. Sec. 168(b)(3) and Sec. 168(c). Additionally, the taxpayer must use the mid-month convention whihc provides that property "placed in service during any month (or disposed of during any month)" is treated as place in service for purposes of hte depreciation calculation in the mid-point of that month. I.R.C. Sec. 168(d)(2); Sec. 168(d)(4)(B). The Internal Revenue Code defines a "residential rental property" as one where 80 % or more of gross rentals are derived from rental income from a home or apartment used to provide living accomodations (excluding hotels, motels, etc that are used in a transient manner). I.R.C. Sec. 168(e)(2). Depreciation deductions, insurance premiums, and real estate taxes are often times significant and should not be overlooked.
Residential rental property is what is referred to in the Code as Section 1250 property. See I.R.C. Sec. 1250(c). When a taxpayer disposes of Section 1250 property, special taxation rates apply. Normally, absent Section 1250, a taxpayer's sale of a rental home would result in entirely capital gain treatment (currently, a preferential rate of 15 %). However, Section 1250 property dispositions or sales require the taxpayer to essentially treat the depreciation deductions taken as ordinary income subject to a 25 % tax rate. If there is any excess over the deductions taken, the remaining balance is treated as a capital gain.
Example: Alice has one rental home in New Jersey. Alice's adjusted basis in the home was $100,000. After 7 years of renting the home, and taking $25,000 in depreciation deductions, Alice decides to sell the home to Homer for $150,000. Alice's amount realized is $75,000 [the $150,000 Alice received as the sales price minus her current adjusted basis of $75,000]. Because Alice has taken $25,000 in depreciation deductions, $25,000 of the gain will be Section 1250 gain and taxed at 25 % (tax practioners refer to the $25,000 amount as "depreciation recapture"). The remaining $50,000 will be taxed as a capital gain (currently 15 %).
A word of caution here about depreciation deductions. I.R.C. Section 1250 refers to the depreciation recaputure amount as the amount of depreciation allowed or allowable. See I.R.C. Sec. 1250(b)(3). Thus, if you decide you do not want to take the depreciation deductions (maybe out of fear that you do not want to have Section 1250 gain later), the Code treats it as if you took the deductions anyway!