Income – Schedules K-1 and Rental
12-1
Introduction
This lesson covers the reporting of:
• Certain income from Schedules K-1 (Forms 1065, 1120S, and 1041). Volunteers who certify at the
Advanced level are permitted to prepare a Schedule E, Supplemental Income and Loss, only with
Schedule K-1 income items identied in this lesson or Form 1099-MISC, Box 2, Royalties, with no
associated expenses.
• Rental income and expenses are in scope only for military families renting their personal residence.
Taxpayers are not required to report income and expenses if their home is rented less than 15 days.
• Rental income and expenses are in scope only for the Military course. Volunteers must certify at
Military level to prepare Schedule E for rental income.
Rental income and expenses are in-scope only for military families renting their personal residence. Generally,
the at-risk and passive activity issues in this lesson are beyond the scope of the VITA/TCE programs. These
issues are referenced for those assisting military members living abroad who have limited access to resources and
professional preparers.
It is important to ensure that all income is accurately reported on the return. Ask taxpayers if they rented out
their home during the tax year or if they received a Schedule K-1 (Form 1041, Form 1065, or Form 1120S)
from an estate, trust, partnership, or S corporation.
This lesson does not apply to taxpayers who are in the business of renting properties.
Income – Schedules K-1 and Rental
What do I need?
□ Form 13614-C
□ Publication 4012
□ Publication 17
□ Schedule A
□ Schedule E
Optional:
□ Publication 527
□ Publication 541
□ Publication 551
□ Publication 559
□ Publication 925
□ Publication 946
□ Form 8582
□ Schedule K-1 (Form 1041
and Instructions)
□ Schedule K-1 (Form 1065
and Instructions)
□ Schedule K-1 (Form 1120S
and Instructions)
Objectives
At the end of this lesson, using your resource materials, you will be
able to:
• Identify Schedule K-1 income items that are within the scope of the
VITA/TCE programs
• Determine how to report Schedule K-1 income items
• Determine which types of rental income must be reported
• Identify how to report rental expenses
Income – Schedules K-1 and Rental
12-2
Schedule K-1, Beneciary’s Share of Income, Deductions, Credits, etc.
What is reported on Schedule K-1?
Schedule K-1 is used to report the taxpayer’s share of income, other distributions, deductions, and credits
from partnerships, S corporations, and some estates and trusts. One copy of Schedule K-1 is sent to the
IRS and is later matched with individual returns. Another copy of Schedule K-1 is sent to the taxpayer. Ask
taxpayers if they received a Schedule K-1 from such an entity that reects their share of income, reportable
on their Form 1040. It is important to correctly report this income to avoid notices or correspondence from
the IRS.
How and where can income be reported?
Income reported on Schedule K-1 will be included on the taxpayer’s return in various places depending
upon the type of income. Income reported on Schedule K-1 that is within the scope of the VITA/TCE
programs includes:
• Interest income
• Dividend income
• Qualied dividends income
• Section 199A dividends
• Net short-term capital gains and losses (Schedule D, line 5)
• Net long-term capital gains and losses (Schedule D, line 12)
• Tax-exempt interest income
• Royalty income (Schedule E)
In Part I of Schedule E, enter a code 6 for royalties. Refer to the Schedule E Instructions for more information.
Royalty income is in scope for the VITA/TCE programs only when the source document of the royalty
income is reported on Schedule K-1 or Form 1099-MISC, Box 2, Royalties, with no associated expenses. Depletion
allowances and any other income, deductions, credits, etc., reported on Schedule K-1 are out of scope for the VITA/
TCE programs, and the taxpayer should be referred to a professional tax preparer. Note: Foreign taxes reported on
Schedule K-1 may be within scope. See the Foreign Tax Credit lesson for more information.
Schedule K-1 (Form 1041)
The duciary of a domestic decedent’s estate, trust, or bankruptcy estate uses Form 1041 to report income,
gains, losses, etc., of the estate or trust.
Taxpayers receive Form 1041, Schedule K-1, to report their share of income from interest, dividends
(ordinary and qualied), and capital gains (net short-term and net long-term). The taxpayer’s income
from these sources should be reported on the appropriate forms and schedules as listed on Form 1041,
Schedule K-1, page 2.
Income – Schedules K-1 and Rental
12-3
Schedule K-1 (Forms 1065 and 1120S)
Partnerships use Form 1065, Schedule K-1, to report the taxpayers’ share of the partnership’s income,
deductions, credits, etc. In general, a partnership is not subject to income tax and is a ow-through
entity. This means the income ows through to the partners, who pay tax on their allocated share of the
partnership income on their individual Forms 1040.
S corporations use Form 1120S, Schedule K-1, to report the taxpayers’ share of the corporation’s income
(reduced by any tax the corporation paid on the income), as well as any deductions, credits, etc. The S
corporation is also a ow-through entity with the reported income owing through to each shareholder.
Shareholders pay tax on their allocated share of the income on their individual Forms 1040.
Taxpayers receive a Schedule K-1 (Form 1065 or Form 1120S) reporting their share of income from interest,
dividends (ordinary and qualied), and capital gains (net short-term and net long-term) from partnerships
and corporations. Schedule K-1, page 2, lists the appropriate forms and schedules where taxpayers’ income
from these sources should be reported.
Schedules K-1 are not led with the tax return. Advise taxpayers to keep Schedules K-1 with their records.
What is rental income?
Generally, payment received for renting a room or a home to a tenant is rental income reportable on Form
1040, Schedule E. U.S. citizens and resident aliens must report rental income, regardless of whether
the rental property is located in the U.S. or in a foreign country. Gross rental income may include other
payments in addition to the normal and ordinary rents received, such as:
• Advanced rent
• Security deposits, if it represents rental income
• Payments for breaking a lease
• Expenses paid by the tenant
• Fair market value of property or services received instead of rental payments
Residential rentals are in scope with Military certication when the taxpayer is active military only.
The security deposit is not included in income when the taxpayer plans on returning the deposit at the end of
the lease. However, if the security deposit is intended to serve as the last month’s rent, then it should be included in
income when received.
The taxpayer’s method of accounting aects when the rental income is reported. The cash method reports
income when received and expenses when paid; most individuals use this method. The accrual method
reports income when earned and expenses when incurred, and is out of scope for the VITA/TCE programs.
Refer taxpayers using the accrual method of accounting to a professional tax preparer.
Rental of a residence only is in scope. Renting personal property, such as equipment or vehicles, is out of
scope for the VITA/TCE Programs.
Income – Schedules K-1 and Rental
12-4
In completing Schedule E, the following should be answered:
• Question A – Check the box “Yes” or “No” to the question: Did the taxpayer make any payments in the
current year that would require the ling of Form 1099? If Yes, the return is out of scope.
• Question B – If Yes, did or will the taxpayer le all required Forms 1099? Check the box “Yes” or “No.”
• In Part I, line 2 – The number of fair rental value days and number of personal use days is reported on
Schedule E.
Tax Software Hint: For software entries, see the Volunteer Resource Guide, Tab D, Income.
It is important that property be rented at fair rental value. If a property is rented at less than fair rental value,
the income and expenses are reported in a dierent manner than discussed in this lesson. Refer taxpayers who rent
their property at less than fair rental value to a professional tax preparer.
What qualies as a rental expense?
Taxpayers who reside in homes they own generally itemize and deduct mortgage interest and property
taxes on Schedule A. However, when a taxpayer rents out a home, those become rental expenses along
with the cost of certain other operating expenses. Taxpayers who do not use the rental home as their
residence should:
• Include the rent as income and
• Deduct all of the rental expenses, even if they exceed income
Mortgage interest and property taxes
Mortgage interest on a loan used to buy or improve the property and property taxes are deductible as rental
expenses. If the residence (or a portion of the residence) was used as rental property for any part of the
year, the taxpayer must allocate the property tax and mortgage interest deductions between Schedule A
and Schedule E.
In general, taxpayers use Schedule A, Itemized Deductions, to report the portion of the mortgage interest
and property taxes that apply to their use of the home. That portion can be based on a percentage of time
(4 months as a residence and 8 months used as rental) or based on an area (1,500 sq. ft. as a residence
and 500 sq. ft. as the rental portion). For the part of the year and/or the portion of the home that is rented
out, taxpayers report rental income and expenses (including a portion of the mortgage interest, property
taxes, and other expenses that relate to the rental time/portion of the home) on Schedule E, Supplemental
Income and Loss.
If any part of the property tax is designated for local benets that increase the value of the property, such as
streets and sidewalks, that portion of the tax is added to the basis of the property rather than deducted as
an ordinary rental expense or an itemized deduction.
Mortgage interest is reported to the taxpayer on Form 1098, Mortgage Interest Statement. This statement
may also include property taxes. If it does not, the taxpayer should have a document from the local taxing
authority.
Generally, mortgage interest expense is fully deductible. However, refer taxpayers with rental-related interest
expenses other than mortgage interest to a professional tax preparer.
Income – Schedules K-1 and Rental
12-5
What are other deductible rental expenses?
In addition to mortgage interest and property taxes, deductible rental property expenses may include these
items listed on Schedule E:
• Advertising
• Auto and travel expenses to check on the property or to collect rents
• Cleaning and maintenance
• Commissions paid for collecting rental income
• Insurance premiums
• Mortgage points
• Legal and professional fees
• Property management fees
• Repairs
• Utilities
• Other rental-related expenses, such as rental of equipment, long distance phone calls, and
condominium/cooperative maintenance fees
Transportation expenses incurred to travel between a taxpayer’s home and rental property generally constitute
nondeductible commuting costs unless the home is the taxpayer’s principal place of business.
When a tenant does not pay the rent, a cash-basis landlord cannot take a deduction for the unpaid rent.
Taxpayers cannot take a deduction for a payment they did not include in income.
example
Paul Kingman lived in his home through September, when he was notied he was being transferred
overseas. He rented his home beginning in October. The total amount of Paul’s mortgage interest for
the tax year was $2,400 and his property taxes were $600. Report nine months (January–September) of
mortgage interest and property taxes as itemized deductions on Schedule A, that is, $1,800 and $450,
and the other three months (October–December) as expenses on Schedule E, that is, $600 and $150.
EXERCISES
Question 1: John Princeton was transferred overseas and began renting out his residence on
September 1 of the tax year. How much of his mortgage interest and property taxes should be reported
on his Schedule E?
A. All of it
B. Eight-twelfths (2/3 or 67%)
C. Four-twelfths (1/3 or 33%)
D. None of it
Income – Schedules K-1 and Rental
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What about property insurance?
The property insurance that taxpayers pay on their residence is deductible as a rental expense for the time
it is considered rental property. If the residence is rented for part of the year, only the amount that covers the
rental period is deductible. If a portion of the residence is rented, the deductible portion must be allocated
and deducted on Schedule E.
Insurance premiums paid more than one year in advance cannot be deducted in one year. All taxpayers
must prorate advanced premium payments over the period covered by the policy. The only portion
deductible in the current year is that amount that covers the current year. The remainder is spread out over
the life of the insurance coverage.
Can travel expenses away from home be deducted as rental expenses?
Taxpayers can deduct ordinary and necessary travel and transportation expenses of traveling away from
home if the primary purpose of the trip is to collect rental income or to manage, conserve, or maintain the
rental property. If the travel was in or outside of the U.S., taxpayers should substantiate the pleasure vs.
business portions of the trip and allocate the expenses accordingly.
Taxpayers who use their personal automobile for rental-related trips may use either the standard mileage
rate or the actual expense method for business mileage. However, if the taxpayers wish to use the actual
expense method, refer them to a professional tax preparer.
The standard mileage method multiplies the miles driven for business by a standard rate. The standard rate
includes all expenses of operating the vehicle. Only parking and tolls can be added to the standard mileage
deduction. See Publication 463, Travel, Gift, and Car Expenses, for the current year standard mileage rate.
Taxpayers may use the standard mileage rate only if they meet one of these requirements:
• The vehicle was owned and used the standard method the rst year the vehicle was placed into service
or
• The vehicle was leased and used the standard method for the life of the lease
The actual expense method gures the deduction based on a variety of factors, including gasoline, oil,
repairs, insurance, and rentals and may even involve depreciation or the value of a vehicle provided by the
taxpayer’s employer.
This lesson discusses only the standard mileage rate. If taxpayers wish to use the actual method, refer them to
a professional tax preparer.
Are repairs and improvements deductible?
Taxpayers often misunderstand when an expense qualies as a repair or an improvement. A repair keeps
the property in good operating condition; the cost is a current year deduction. An improvement adds to
the life or material value of the property, prolongs its useful life, or adapts it to new uses. This cost must
be depreciated over the recovery period for the improvement. The total cost of an improvement includes
material, labor, and installation.
Taxpayers can elect to expense repair, improvement, or purchased items that might otherwise have to be
capitalized. Items that cost $2,500 or less can be expensed immediately by using the de minimis election
in the regulations. When the taxpayer makes this election, it applies to all eligible items paid during the
year. Note that this is not a Section 179 expense election, which is shown on Form 4562, Depreciation and
Amortization. Instead, the expense is shown as repairs or other expense on Schedule E.
Income – Schedules K-1 and Rental
12-7
Taxpayers cannot deduct the cost of their own labor when making repairs.
See the table below for examples of repairs and improvements.
Repairs (Deduction) Improvements (Depreciation)
Painting Adding a room
Fixing gutters Installing a new fence
Repairing driveways Putting in plumbing or wiring
Replacing window glass Replacing a hot water tank
Repairing the roof Putting on a new roof
Repairing appliances Replacing/adding major appliances
Tax Software Hint: For software entries, go to the Volunteer Resource Guide, Tab D, Income.
Additional information on rental income can be found in Publication 527, Residential Rental Property and
Publication 946, How to Depreciate Property.
How do I handle depreciation of rental property?
The cost of property with a useful life of one year or more, and used in a trade or business or held for the
production of income (such as rent), is recovered by deducting an expense called depreciation.
“Depreciable property” includes buildings, machinery, furniture, equipment, vehicles, and any cost for
additions or improvements to rental property. The value of land, however, is not depreciable; therefore, the
cost of clearing, grading, planting, or other land improvements are also not depreciable.
Depreciation allows the taxpayers to deduct some of the cost of the property each year on their tax return.
The annual amount of depreciation on property reduces the taxpayers’ basis in that property. Taxpayers
should claim the correct amount of depreciation expense every year. Even if they did not deduct the
depreciation expense during any tax year, they must still reduce their basis in the property by the amount of
depreciation that they should have deducted.
What factors determine the amount of depreciation to deduct?
The factors that determine the depreciation amount are:
• Depreciation method used
• Basis of the property
• Recovery period for the property
Depreciation Method
The most common methods for determining depreciation are:
• Straight line or declining balance: Property placed in service before 1981
• ACRS (Accelerated Cost Recovery System): Property placed in service after 1980, but before 1987
• MACRS (Modied Accelerated Cost Recovery System): Property placed in service after 1986
Income – Schedules K-1 and Rental
12-8
What is considered the basis and adjusted basis for depreciation purposes?
Generally, the basis for depreciation is the purchase price of the property, including the cost of
improvements, but not including the value of the land. When property is converted from personal use to
rental use, the basis is the lesser of the adjusted basis or fair market value (FMV) at the time of conversion.
The total of the yearly expense deductions for depreciation can never total more than the basis of the
property.
Form 4562, Depreciation and Amortization
Taxpayers must complete and attach Form 4562 for rental activities only if claiming:
• Depreciation, including the special depreciation allowance, on property placed in service during the year
(out of scope)
• Depreciation on listed property (such as a car), regardless of when it was placed in service (out of
scope)
• Any other car expenses, including the standard mileage rate or lease expenses (out of scope)
Otherwise, taxpayers should gure the depreciation on their own worksheet. Do not attach these
computations to the return, but taxpayers should keep them in their records for future reference.
Tax Software Hint: For depreciation software entries, go to the Volunteer Resource Guide, Tab D,
Income.
How do I handle rental property that the taxpayer also uses?
When the rental property is a portion of the taxpayer’s residence, the rental income and expenses must be
allocated separately from the taxpayer’s personal expenses.
How do I dierentiate between rental expenses and personal use expenses?
Expenses that apply to only the rental part of a property are direct business expenses and should be
reported in full on Schedule E. The cost of installing a second phone line strictly for a tenant’s use, for
example, is deductible as a rental expense. However, the taxpayer cannot deduct any part of the cost of the
rst phone in a partially-rented property, even if tenants use it.
Expenses that benet the entire property (indirect expenses) must be allocated between rental use and
personal use; the rental portion is reported on Schedule E.
EXERCISES (continued)
Question 2: All of the following are examples of deductible rental expenses except _____.
A. Carpet cleaning fees
B. Charges for phone calls made to the property manager
C. Gas and electric bills paid for the rental property
D. Repairs made to the homeowner’s personal residence
Question 3: Which of the following rental expenses must be recovered by taking depreciation?
A. Home insurance premiums
B. Painting
C. Installing a backyard fence at a cost of $3,500
D. Repairing a broken furnace
Income – Schedules K-1 and Rental
12-9
EXERCISES (continued)
Question 4: For taxpayers who rent part of a property in which they live, which expenses are reported
only on Schedule E and not on Schedule A?
A. Home insurance and mortgage interest
B. Property taxes and repairs
C. Utilities and home insurance
D. Depreciation and property taxes
example
Charles used his rental property for personal use 7 days and rented it for 63 days. In most cases, 10%
of Charles’ expenses are not rental expenses and cannot be deducted on Schedule E (7 = 10% of 70
total days: 7 personal days + 63 rented days).
If deductions are itemized, the personal portion of home mortgage interest and property tax may be
reported on Schedule A. The taxpayer can choose any reasonable method to allocate the expenses.
The most common methods are based on the number of rooms in the dwelling or on the total area of the
dwelling.
On Schedule E, report expenses that apply exclusively to the rental portion and the applicable percentage
of expenses that benet the entire house. For example, if the rented portion is 10% of the property, the
taxpayer could deduct:
• 100% of the cost to wallpaper the tenant’s room
• 10% of property taxes, utilities, mortgage interest, and depreciation
When taxpayers can itemize personal deductions on Schedule A, they can report the deductible expenses
that benet the entire house minus the percentage that applies to the rental portion. In Gloria’s case, if she
is treating the rental portion as 10% of the residence, she can deduct the following on Schedule A:
• 90% of the mortgage interest
• 90% of the property taxes
Expenses related to days of personal use do not qualify as rental expenses. The taxpayer must allocate the
expenses based on the number of days of personal use to total use of the property.
example
Gloria rents one room in her 1,200 square foot house to a tenant. The rental room measures 10 feet by
12 feet (120 square feet, or 10% of the total house). She may deduct:
• 100% of any expenses that relate only to the rental portion of the house, such as repairs or upgrades
to the rented room
• 10% of any qualied expense that benets the entire house
Income – Schedules K-1 and Rental
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example
On February 28, Trent moved out of the house he had lived in for six years because he was deployed
overseas. He rented his house at a fair rental price from March 15 last year to May 14 this year. On
June 1 this year, he returned from his deployment and moved back into his house. Because he rented
his property for 12 or more consecutive months, his use of the house is not counted as personal use.
Since these days are not counted as days of personal use, the limitations on deductions do not apply.
How should taxpayers report rental expenses that exceed their rental income when they
live in the home for part of the year?
Questions in Part I, line 2 of Schedule E ask for information on the number of rental days at fair rental value
and the number of days for personal use. If taxpayers rented out a dwelling unit that they also used for
personal purposes during the year, they may not be able to deduct all the expenses for the rental part.
Dwelling unit (the unit) means a house, apartment, condominium, or similar property. A day of personal
use is any day, or part of a day, that the unit was used by:
• The taxpayer for personal purposes,
• Any other person for personal purposes, if that person owns part of the unit (unless rented to that
person under a “shared equity” nancing agreement),
• Anyone in the taxpayer’s family (or in the family of someone else who owns part of the unit), unless the
unit is rented at a fair rental price to that person as his or her main home,
• Anyone who pays less than a fair rental price for the unit, or
• Anyone under an agreement that lets the taxpayer use some other unit
Are there any exceptions?
Taxpayers who used a dwelling unit as their main home may not have to count all that time as “days of
personal use.” Do not count as personal use any day the taxpayer:
• Spends working substantially full time repairing and maintaining the unit, even if a family member used
it for recreational purposes on that day, or
• Used the unit as the taxpayer’s main home before or after renting it or oering it for rent, if the taxpayer
rented or tried to rent it for at least 12 consecutive months (or for a period of less than 12 consecutive
months at the end of which the taxpayer sold or exchanged the home).
However, this special rule doesn’t apply when dividing expenses between rental and personal use.
Are there any limitations?
There are limitations based on whether the taxpayer used the dwelling unit as a home and it meets the
personal use test. The personal use test is met if the taxpayer used the unit for personal purposes in the
current tax year more than the greater of:
• 14 days or
• 10% of the total days it was rented to others at a fair rental price
Fair rental days and personal use days are reported in Part I, line 2, of Schedule E.
If the taxpayer did not use the dwelling unit as a home, the taxpayer can deduct all the expenses for the
rental part, subject to the At-Risk Rules and the Passive Activity Loss Rules. For more details on these
rules, refer to Publication 527, Residential Rental Property (Including Rental of Vacation Homes).
Income – Schedules K-1 and Rental
12-11
If the taxpayer used the dwelling as a home and rented the unit for fewer than 15 days in the current
tax year, do not report the rental income and do not deduct any rental expenses. If the taxpayer itemizes
deductions on Schedule A, the taxpayer can deduct allowable interest, taxes, and casualty losses.
(Remember that the topic of casualty losses is out of scope for the VITA/TCE programs.)
If the taxpayer used the dwelling as a home and rented out the unit at least 15 days in the current tax
year, the taxpayer may not be able to deduct all of the rental expenses. The taxpayer can deduct all of the
following expenses for the rental part on Schedule E:
• Mortgage interest
• Real estate taxes
• Casualty losses (out of scope)
• Other rental expenses not related to the taxpayer’s use of the unit as a home, such as advertising
expenses and rental agents’ fees
If there is rental income left after deducting these expenses, the taxpayer can deduct other expenses,
including depreciation, up to the amount of remaining income. The taxpayer can carry over to the following
tax year the unused expense amounts.
Tax Software Hint: If the property was used as a rental for the entire year, the income and expenses
can be reported on Schedule E. If the property was used partially as a rental and partially as a residence,
some expenses may need to be allocated. For software entries, go to the Volunteer Resource Guide, Tab
D, Income.
How do I handle rental losses?
Deducting all rental expenses and depreciation from the rent received may result in a net loss. Rental
losses are not always fully deductible. There are two restrictions on how much a loss can oset other
sources of income:
• At-risk rule
• Passive activity rules
What is the at-risk rule?
The at-risk rule places a limitation on the amount the taxpayer can deduct as losses from activities often
described as tax shelters. Generally, any loss from an activity subject to the at-risk rules is allowed only to
the extent of the total amount the taxpayer has at risk in the activity at the end of the tax year.
What are the passive activity rules?
The passive activity rules state that passive activity losses can be deducted only from passive activity
income. Passive income does not include salary, dividends, or other investment income but is generally
attributed to such things as rental income. Therefore, losses that exceed rental income (the passive activity)
are not deductible. However, some losses may be deductible if an exception is met.
Income – Schedules K-1 and Rental
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EXERCISES (continued)
Question 5: Which restriction limits the deductibility of rental loss to the amount of rental income?
A. Phase-out of oset
B. Passive activity rules
C. Active participation rule
Passive income and active participation
The limits on deducting rental losses are aected by the degree to which renting out the property is a
passive activity or involves active participation:
• Passive rental activity means receiving income mainly from the use of property rather than for services.
• Active participation means making signicant management decisions, such as approving rental terms,
repairs, expenditures, and new tenants. Taxpayers who use a leasing agent or property manager could
be considered active participants if they retain nal management rights.
Exception
Rental activities are generally considered passive activities. For this reason, rental losses are not fully
deductible. However, an exception to the passive activity rule provides that taxpayers who actively
participate in the rental activity can use up to $25,000 of their rental losses to oset any other nonpassive
income ($12,500 for married taxpayers ling separately and living apart for the entire year). Examples of
nonpassive income are salaries, wages, commissions, tips, self-employment income, interest, dividends,
annuities, and some royalties. (This deduction is reduced if the taxpayer’s adjusted gross income (AGI)
exceeds certain limits.)
What is active participation?
It is considered active participation when taxpayers own at least 10% of the rental property and make
management decisions in a signicant and bona de sense. Management decisions include approving new
tenants, deciding on rental terms, approving expenditure, and similar decisions.
For more information, see Publication 925, Passive Activity and At-Risk Rules.
Phase-Out of Oset
The amount allowed to oset nonpassive income is reduced if taxpayers’ modied adjusted gross income
exceeds certain amounts. See Publication 925 for the AGI limits.
How are passive rental losses reported?
Taxpayers use Form 8582, Passive Activity Loss Limitations, to gure the amount of any passive activity
loss allowed for the current tax year. Form 8582 summarizes losses and income from all passive activities.
Generally, taxpayers are not required to le Form 8582 if they have:
• Only one passive loss generated from a rental activity and
• An AGI of less than $100,000
Completing Form 8582 is out of scope if volunteers are required by the software to enter additional data in
Form 8582. For example, if passive activity losses exceed $25,000 ($12,500 for Married Filing Separately)
and require a computation of unallowed passive activity losses, then the return is out of scope.
Income – Schedules K-1 and Rental
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Summary
Taxpayers receive Schedule K-1 (Form 1065, Form 1041, or Form 1120S) reporting their share of income
from ow-through entities. Interest, dividends (ordinary and qualied), and capital gains (net short-term and
net long-term) are in scope. Schedule K-1, page 2, lists the appropriate forms and schedules where the
taxpayers’ income from these sources should be reported. Additionally, royalties on Schedule K-1, Forms
1065 and 1120S are within scope. Volunteers who certify to the Advanced level are permitted to prepare a
Schedule E only with Schedule K-1 income items.
Rental income and deductible rental expenses are reported on Part I of Schedule E, Supplemental Income
and Loss. Volunteers must certify at the Military level to prepare a Schedule E for rental income. Rental
income and expenses are in-scope only for military families renting their personal residence.
U.S. citizens and resident aliens must report rental income for the months their home is rented, regardless
of whether the rental property is located in the U.S. or in a foreign country.
When renting out part of the property, certain expenses must be allocated between rental use and personal
use. Some are reported on Schedule A and some on Schedule E.
Taxpayers who do not use a dwelling unit as a home (for personal purposes) should include all the rent in
their income and deduct all the rental expenses. There are special rules and limitations if the taxpayer used
the dwelling unit as a home and it meets the personal use test.
Rental income and expenses are not reported if the taxpayer used the dwelling as a home and rented the
unit for fewer than 15 days in the current tax year. If the taxpayer itemizes deductions on Schedule A, the
taxpayer can deduct allowable interest, taxes, and casualty losses. (Remember that the topic of casualty
losses is out of scope for the VITA/TCE programs.)
Because rental activities are generally considered passive activities, rental losses are not fully deductible.
However, taxpayers who actively participated in the renting of the property may deduct up to $25,000 of
their rental losses, up to $12,500 for married taxpayers ling separately and living apart. This deduction is
subject to phase-out rules if the taxpayer’s AGI exceeds certain limits.
The passive activity rules state that passive activity losses can be deducted only from passive activity
income. Taxpayers with rental losses may be required to le Form 8582, Passive Activity Loss Limitations.
What situations are out of scope for the VITA/TCE programs?
The following are out of scope for this lesson. While this list may not be all inclusive, it is provided for your
awareness only.
• Income reported on Schedules K-1 (other than what is listed in the introduction to this lesson)
• Deductions, credits, and other items reported on Schedules K-1 (other than listed above)
• Royalty income reported on Form 1099-MISC with associated expenses
• Rental income and expenses for non-military taxpayers
• Taxpayers who rent their property at less than fair rental value
• Rental-related interest expenses other than mortgage interest
• The actual expense method (auto and travel expense deductions)
• Casualty loss
• Completing Form 8582 if volunteers are required to enter additional data in Form 8582 in the software
• Completing Form 4562
• Taxpayers who led or need to le Form(s) 1099
Income – Schedules K-1 and Rental
12-14
TAX LAW APPLICATION
To gain a better understanding of the tax law, complete the practice return(s) for your course of study
using the Practice Lab on L<.
EXERCISE ANSWERS
Answer 1: C. You would deduct four-twelfths (33%) of his mortgage interest and taxes on Schedule E,
and report the other 67% on Schedule A.
Answer 2: D. Repairs made to the homeowner’s personal residence are not deductible as rental
expenses. However, the other expenses are deductible, along with repairs made to rental property,
legal and professional fees, and property management fees.
Answer 3: C. The fencing adds value to the property and would have to be capitalized and depreciated.
Answer 4: C. The rental portions of utilities, home insurance, repairs, and depreciation are rental
deductions on Schedule E, but the personal portions are not a deductible expense reported on
Schedule A. Taxpayers who rent out part of a property allocate mortgage interest and property taxes
separately on both schedules.
Answer 5: B. Passive activity losses can be deducted only from passive activity income. Taxpayers
who are not active participants may not deduct rental losses that exceed rental income.
