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Rental Income Tax Forms: Property Owner, Partnership or LLC

Rental Income Tax Forms: Property Owner, Partnership or LLC
Ines Zemelman, EA
14 October 2021

Tax Forms in a Nutshell — Reporting Profits and Losses

Form 1040 Schedule E is your rental income tax declaration form. It is for rental income and deductions — but also asks questions. For example, Schedule E requires realty investors to confirm that reporting rules, Form 1099 - MISC, were observed. The IRS is interested in your rental income, but is looking for payments by you that are taxable income to the one receiving money.

Schedule E includes go-elsewhere instructions. Examples are directing personal property renters to Schedule C, the business income schedule. Another portion of the return reports farm rental income. Individual hotel/motel owners (hospitality and service combined with the realty) report business income on Schedule C.

Schedule E asks questions such as personal use days. Types of property are disclosed with distinctions such as commercial, single family and multi-family residence rentals.

Schedule E quickly gets to the business of reporting rental income and deductions. And security deposits, prior to forfeiture, generally aren’t taxable as rental or other income. If there is a rental loss, taxpayers (or preparers) are guided to IRS Form 6198 for at-risk limitation rules and Form 8582 for passive activity loss limitation rules. See Section 469.

Passive loss limitation does not apply to real estate professionals. And investors are usually allowed a $25,000 annual rental loss limitation if there is active participation in rental details. This rule turns on at least ten percent ownership and management.

Form 8582 flows income to a more advanced line in the tax return, but leads to possible limitations. The IRS informs taxpayers of items that reduce tax, but it intensely focuses on rules that can increase tax.

Real estate rentals are typically not subject to self-employment tax. Unlike Schedule C (business income schedule), Schedule E real estate rentals do not end up on Form 1040 Schedule SE — where self-employment tax is added.

Business Structure — Partial Ownership Tax

Investors can qualify for co-ownership treatment, as opposed to filing as a partnership. See details in Reg.1.761-2 and discussion in IRS Publication 541, Partnerships (2021), p. 4. A 40% owner might report that percentage of each item of income and expense. In reporting as a partnership, details may lodge more in the partnership return.

Separate filing has advantages and drawbacks. Centralized accounting may be less work. With separate reporting, if permissible, a partial interest owner might qualify for a like-kind exchange deal if the other owners want to keep their current partial interests.

Co-owned realty of spouses often goes directly to one Schedule E joint return.

Business Structure — Partnerships

Partnerships are about the all-important partnership agreement. Use Form 8825 to report income and deductible expenses from real estate rentals. Net rental real estate income for the general partner or limited partner then flows to Form 1065 Schedule K-1 of the partnership return. The partner’s share ends up on Schedule K-1, and is eventually reported on the individual Form 1040 — or on the return of an entity partner. Corporations, S corporations and other partnerships can be partners.

If unique tax rules can apply partner-by-partner, such unique items may be reported separately. A partner’s share of partnership charitable contributions may flow-through as a unique deduction.

To summarize reporting for an individual business owner, use rental income tax forms Form 8825 and Form 1065 K-1, with tax reporting on its way to Form 1040 Schedule E, p. 2. If the partner is a C corporation, partnership return data ends up on Form 1120 of the corporate return.

Business Structure – Corporations and Other Trails

Subchapter S corporations are like partnerships in terms of rental income tax forms. These corporations use Form 8825 to report tax details on real estate rentals — and flow through to shareholders of the S corporation. The end path is usually, but not always, an individual owner’s Form 1040.

Form 1040 Schedule E Part III is devoted to estates and trusts, and Schedule E Part IV is for real estate mortgage investment conduits (REMICs). REMICs are realty related in that they invest in mortgage loans and mortgage-backed securities.

The Limited Liability Company (LLC) Avenue

An LLC with multiple members is normally taxed as a partnership. Multiple owners can opt to have their relationship governed by a partnership agreement rather than an LLC. If you form an LLC as part of your planning, don’t just put the paperwork in a drawer. The LLC will, for example, need a bank account.

A limited liability company (LLC) or multiple LLCs can provide liability protection to reduce the risk of loss. Consult your attorney about your legal liability.

Single-member LLCs are disregarded entities if owned by one individual who takes no further tax steps. Disregarding the entity under income tax rules can prevail when the LLC has rental income, and its owners are a married couple living in a community property state.

If the entity is disregarded, the tax flow is directly reported on Schedule E. A single-member LLC owner can also opt to elect, with paperwork, to be taxed as a C corporation. But realty in a C corporation can be problematic. Sale or distribution of appreciated property may trigger the 21% corporate tax. Getting after-tax proceeds out of C corporations may trigger tax on dividends in shareholder’s Form 1040. Individual rates are as high as 37%.

A corporate structure plus an S election may help with double taxation. However, getting appreciated property out of an S corporation can trigger flow-through gain to the owner’s individual return.

See your tax advisor before having your rental realty in a corporation, or in an LLC that is taxed as a corporation. Income, expense and tax result projections may require a tax planning professional.

Taxes, Taxes, and Yes More Taxes

Federal income tax gets the most attention. But yes, there is more!

As a real estate business owner, keep a close eye on property taxes. For example, increased valuations can arise from ownership changes. But revaluations can turn on the degree of change and local law. If a sister and brother own realty, and one sibling passes, it may be possible to redeem the sibling’s surviving spouse without increasing property taxes. Results can vary depending on the order of steps in ownership change.

Keep in mind federal income tax isn't the only consideration with real estate. Also review how rentals are reported on your state return.

Understanding the particulars of your rental real estate and your rental income tax forms will help you save tax dollars — especially if coupled with expert tax advice!

Ines Zemelman, EA
Founder of TFX