Should You File Schedule C For Rental Property Or Schedule E?
You might be a real estate professional, an accidental landlord or trying to earn a few extra bucks by renting out your dwelling unit or vacation home. Whichever the case is, there are tax consequences for every penny you earn from rental activity. And you need to know while filing your taxes whether to use Schedule E or Schedule C for rental property.
Schedule C and E are the two schedules that are generally used to report the rental income. These schedules are part of Form 1040 which every taxpayer is obligated to file. In this article, you will learn which schedule is relevant in your case. Before we dive into learning about Schedule C vs Schedule E let’s find out what they are.
What Is Schedule C?
Let’s say you are running a business or practicing a profession as a sole proprietor. In this case, you will require to report your income or loss on Schedule C if your business activity meets the following two criteria:
- The fundamental purpose of your business activity is to earn profit.
- You are consistently and regularly involved in your business activity.
What Is Schedule E?
You will use Schedule E to report your passive income which includes self-charged interest, rental properties, and business activities that generate income without requiring material participation.
What’s The Difference? - Schedule C Vs Schedule E
Now let us look at how using Schedule C for rental property is different from Schedule E.
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Schedule C |
Schedule E |
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It is used for reporting business revenue and losses. |
It is used to report rental earnings and losses. |
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The income you report on Schedule C is subject to self-employment tax |
The income you report on Schedule E is not subject to self-employment tax. |
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You are allowed to deduct any business expenses on Schedule C that are ordinary and necessary in running your operations to lower your taxable income. |
No deductions are allowed on Schedule E. |
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Because you materially engage in your business you are not subject to passive activity rules and your losses are not capped. |
You are subject to passive activity rules which limit the losses you are allowed to deduct. |
On Which Schedule Should I Record Property Income?
Whether you will report your rental income on Schedule C or Schedule E will depend on various factors.
When To Use Schedule C For Rental Property?
If you are an investor and own multiple rental properties you may want to opt for the real estate professional and report rental income on Schedule C provided that you qualify for it. If one is engaged in a rental real estate activity in which one materially participates then they might qualify as a real estate professional.
IRS distinguishes between material participation and active participation. IRS lists out seven tests to determine whether or not your participation in rental activities is material. Your participation in an activity is considered material if you
- Work 500 hours or more during the tax year.
- Do substantially all the work.
- Work more than 100 hours and no one else matches that level.
- Work more than 500 hours and the activity is a significant participation activity.
- Participated in any 5 of the prior 10 years.
- Participated in any 3 prior years and the activity is a personal service
- Participate on a regular, continuous, and substantial basis during the tax year.
If it is established that your participation is material then your losses are considered non-passive and are deductible in full.
On the other hand, the active participation relates only to rental estate activities and is less strict than the material participation. If you are making a management decision you can deduct up to $25000 in losses against non-passive income.
By choosing to be treated as a real estate professional you will be able to combine all your activities which will let you use the passive losses that were previously restricted.
When To Use Schedule E For Rental Property?
It might not be prudent to elect Schedule C for rental property if there are carried over suspended passive losses. These passive losses are not deductible right away and can be carried over until you have a rental income or other passive income you can deduct them against or you dispose of the entire interest in the property.
In this case, you might want to report your rental income on Schedule E.
It is noteworthy that just because you disposed of your entire interest in an activity does not mean you will always be able to claim unused passive credit. What you can do instead is to elect to increase the basis of the credit property by the amount equal to the portion of unused credit.
If you participate in operating vacation rentals or short-term rentals by providing substantial services it will be classified as a business and you need to report that on Schedule C whereas if your participation is minimal and you offer no substantial services you will report it on Schedule E.
The tax implications of rental income will vary depending on the length of time you rented out your property and to what extent you participated in the day-to-day management of the activity.
The decision whether to opt for Schedule C for rental property or Schedule E depends on a lot of factors. Seek advice from a tax professional to understand how rental income is taxed and ensure you go with the schedule that is legitimate and provides you with maximum tax saving.