Tax Form Schedule E: Supplemental Income and Loss

Tax Form Schedule E, Supplemental Income and Loss, is the Internal Revenue Service (IRS) form filed with your Form 1040 to report income and losses from specific sources. These sources include rental real estate, royalties, partnerships, S corporations, estates, and trusts. On Schedule E, you list your income from these activities and subtract related expenses to calculate a net profit or loss. This final figure is then transferred to your main tax return.

Information and Documentation Needed for Schedule E

For each rental property, you will need its physical address, type, and the dates it was available for rent. Financial documents include any Forms 1099-MISC or 1099-K reporting rent received, Form 1098 showing mortgage interest paid, property tax statements, and insurance premium records. You will also need organized receipts for all other expenses, such as repairs, maintenance, and utilities.

For income from partnerships, S corporations, estates, or trusts, the primary document is the Schedule K-1. This form is provided by the entity and details your share of the income, deductions, and credits. The Schedule K-1 provides the exact amounts to transfer to Schedule E, so ensure you have a separate one for each investment.

Reporting Rental and Royalty Income and Expenses

Part I of Schedule E is for reporting financial activity from rental real estate and royalties. You must report the total gross rental income received, which includes regular monthly payments, advance rent, payments for lease cancellation, and any expenses paid by the tenant on your behalf. All income connected to the property must be aggregated and entered on the form.

After reporting income, you can deduct expenses to reduce your taxable profit. A significant deduction is mortgage interest, reported by your lender on Form 1098, along with property taxes. If the property was also used for personal purposes, you must only deduct the portion of expenses that corresponds to the rental activity.

Other common deductible expenses include:

• Advertising costs to find tenants
• Cleaning and maintenance to keep the property in good condition
• Insurance premiums for landlord, liability, or flood policies
• Legal and professional fees paid to attorneys or accountants
• Management fees paid to a property management company
• Repair costs, such as fixing leaks or broken windows
• Utilities you pay for as the landlord, like water or trash collection

Calculating and Claiming Depreciation on Rental Property

Depreciation is a tax deduction allowing property owners to recover the cost of their rental building over time, accounting for wear and tear. You cannot depreciate the value of the land, only the building. This deduction can substantially reduce your taxable rental income.

The calculation begins with determining the property’s basis, which is the amount you paid for it, including certain settlement fees, closing costs, and the cost of any improvements. You must subtract the value of the land from this total cost to find the depreciable basis of the building. This allocation between land and building can be found on property tax records or a professional appraisal.

The IRS requires using the Modified Accelerated Cost Recovery System (MACRS) to depreciate residential rental property. Under MACRS, the recovery period for these properties is 27.5 years. You will deduct a portion of the property’s basis each year over this period using the straight-line method.

The depreciation calculation is performed on Form 4562, Depreciation and Amortization. For the first year a property is in service, a mid-month convention applies, giving you a half-month of depreciation regardless of the rental start date. The final calculated amount from Form 4562 is then transferred to the depreciation line on Schedule E.

Reporting Income from Partnerships, S Corporations, Estates, and Trusts

Parts II and III of Schedule E are for reporting income or losses from partnerships, S corporations, estates, and trusts. For these entities, you do not perform original calculations of income and expenses. Instead, you transfer the data provided to you on a Schedule K-1.

The Schedule K-1 you receive from the entity breaks down your individual share of its financial activity. The instructions with the K-1 guide you on where to report these amounts. For Schedule E, you will find the box on the K-1 that reports your share of net income or loss and enter that figure in Part II or III, using a separate line for each K-1 you receive.

Applying Passive Activity Loss Limitations

After calculating your total income or loss on Schedule E, you may be subject to passive activity loss (PAL) limitations. A passive activity is any rental activity or a business in which you do not materially participate. The rule is that passive losses can only be used to offset passive income, not other income like wages.

This limitation is calculated on Form 8582, Passive Activity Loss Limitations. Any losses that cannot be deducted in the current year are suspended and carried forward to offset passive income in future years. This prevents using passive investment losses to create tax shelters against other income.

An exception to the PAL rules is the special allowance for active participation in rental real estate. If you actively participate and your modified adjusted gross income (MAGI) is below a certain threshold, you may deduct up to $25,000 of rental losses against non-passive income. This allowance phases out for taxpayers with a MAGI between $100,000 and $150,000.

Another exception is for individuals who qualify as real estate professionals by spending a required amount of time in real property trades or businesses. If you qualify, your rental real estate activities are not automatically considered passive. This may allow you to deduct losses without being subject to the same limitations.