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TaxactTaxact 1. Taxact Rental Income and Expenses (If No Personal Use of Dwelling) Table of Contents Rental IncomeWhen To Report Types of Income Rental ExpensesWhen To Deduct Types of Expenses This chapter discusses the various types of rental income and expenses for a residential rental activity with no personal use of the dwelling. Taxact Generally, each year you will report all income and deduct all out-of-pocket expenses in full. Taxact The deduction to recover the cost of your rental property—depreciation—is taken over a prescribed number of years, and is discussed in chapter 2, Depreciation of Rental Property. Taxact If your rental income is from property you also use personally or rent to someone at less than a fair rental price, first read the information in chapter 5 , Personal Use of Dwelling Unit (Including Vacation Home). Taxact Rental Income In most cases, you must include in your gross income all amounts you receive as rent. Taxact Rental income is any payment you receive for the use or occupation of property. Taxact In addition to amounts you receive as normal rental payments, there are other amounts that may be rental income. Taxact When To Report When you report rental income on your tax return generally depends on whether you are a cash basis taxpayer or use an accrual method. Taxact Most individual taxpayers use the cash method. Taxact Cash method. Taxact You are a cash basis taxpayer if you report income on your return in the year you actually or constructively receive it, regardless of when it was earned. Taxact You constructively receive income when it is made available to you, for example, by being credited to your bank account. Taxact Accrual method. Taxact If you are an accrual basis taxpayer, you generally report income when you earn it, rather than when you receive it. Taxact You generally deduct your expenses when you incur them, rather than when you pay them. Taxact More information. Taxact See Publication 538, Accounting Periods and Methods, for more information about when you constructively receive income and accrual methods of accounting. Taxact Types of Income The following are common types of rental income. Taxact Advance rent. Taxact Advance rent is any amount you receive before the period that it covers. Taxact Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use. Taxact Example. Taxact On March 18, 2013, you signed a 10-year lease to rent your property. Taxact During 2013, you received $9,600 for the first year's rent and $9,600 as rent for the last year of the lease. Taxact You must include $19,200 in your rental income in the first year. Taxact Canceling a lease. Taxact If your tenant pays you to cancel a lease, the amount you receive is rent. Taxact Include the payment in your income in the year you receive it regardless of your method of accounting. Taxact Expenses paid by tenant. Taxact If your tenant pays any of your expenses, those payments are rental income. Taxact Because you must include this amount in income, you can also deduct the expenses if they are deductible rental expenses. Taxact For more information, see Rental Expenses , later. Taxact Example 1. Taxact Your tenant pays the water and sewage bill for your rental property and deducts the amount from the normal rent payment. Taxact Under the terms of the lease, your tenant does not have to pay this bill. Taxact Include the utility bill paid by the tenant and any amount received as a rent payment in your rental income. Taxact You can deduct the utility payment made by your tenant as a rental expense. Taxact Example 2. Taxact While you are out of town, the furnace in your rental property stops working. Taxact Your tenant pays for the necessary repairs and deducts the repair bill from the rent payment. Taxact Include the repair bill paid by the tenant and any amount received as a rent payment in your rental income. Taxact You can deduct the repair payment made by your tenant as a rental expense. Taxact Property or services. Taxact If you receive property or services as rent, instead of money, include the fair market value of the property or services in your rental income. Taxact If the services are provided at an agreed upon or specified price, that price is the fair market value unless there is evidence to the contrary. Taxact Example. Taxact Your tenant is a house painter. Taxact He offers to paint your rental property instead of paying 2 months rent. Taxact You accept his offer. Taxact Include in your rental income the amount the tenant would have paid for 2 months rent. Taxact You can deduct that same amount as a rental expense for painting your property. Taxact Security deposits. Taxact Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. Taxact But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year. Taxact If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Taxact Include it in your income when you receive it. Taxact Other Sources of Rental Income Lease with option to buy. Taxact If the rental agreement gives your tenant the right to buy your rental property, the payments you receive under the agreement are generally rental income. Taxact If your tenant exercises the right to buy the property, the payments you receive for the period after the date of sale are considered part of the selling price. Taxact Part interest. Taxact If you own a part interest in rental property, you must report your part of the rental income from the property. Taxact Rental of property also used as your home. Taxact If you rent property that you also use as your home and you rent it less than 15 days during the tax year, do not include the rent you receive in your income and do not deduct rental expenses. Taxact However, you can deduct on Schedule A (Form 1040), Itemized Deductions, the interest, taxes, and casualty and theft losses that are allowed for nonrental property. Taxact See chapter 5, Personal Use of Dwelling Unit (Including Vacation Home). Taxact Rental Expenses In most cases, the expenses of renting your property, such as maintenance, insurance, taxes, and interest, can be deducted from your rental income. Taxact Personal use of rental property. Taxact If you sometimes use your rental property for personal purposes, you must divide your expenses between rental and personal use. Taxact Also, your rental expense deductions may be limited. Taxact See chapter 5, Personal Use of Dwelling Unit (Including Vacation Home). Taxact Part interest. Taxact If you own a part interest in rental property, you can deduct expenses you paid according to your percentage of ownership. Taxact Example. Taxact Roger owns a one-half undivided interest in a rental house. Taxact Last year he paid $968 for necessary repairs on the property. Taxact Roger can deduct $484 (50% × $968) as a rental expense. Taxact He is entitled to reimbursement for the remaining half from the co-owner. Taxact When To Deduct You generally deduct your rental expenses in the year you pay them. Taxact If you use the accrual method, see Publication 538 for more information. Taxact Types of Expenses Listed below are the most common rental expenses. Taxact Advertising. Taxact Auto and travel expenses. Taxact Cleaning and maintenance. Taxact Commissions. Taxact Depreciation. Taxact Insurance. Taxact Interest (other). Taxact Legal and other professional fees. Taxact Local transportation expenses. Taxact Management fees. Taxact Mortgage interest paid to banks, etc. Taxact Points. Taxact Rental payments. Taxact Repairs. Taxact Taxes. Taxact Utilities. Taxact Some of these expenses, as well as other less common ones, are discussed below. Taxact Depreciation. Taxact Depreciation is a capital expense. Taxact It is the mechanism for recovering your cost in an income producing property and must be taken over the expected life of the property. Taxact You can begin to depreciate rental property when it is ready and available for rent. Taxact See Placed in Service under When Does Depreciation Begin and End in chapter 2. Taxact Insurance premiums paid in advance. Taxact If you pay an insurance premium for more than one year in advance, for each year of coverage you can deduct the part of the premium payment that will apply to that year. Taxact You cannot deduct the total premium in the year you pay it. Taxact See chapter 6 of Publication 535 for information on deductible premiums. Taxact Interest expense. Taxact You can deduct mortgage interest you pay on your rental property. Taxact When you refinance a rental property for more than the previous outstanding balance, the portion of the interest allocable to loan proceeds not related to rental use generally cannot be deducted as a rental expense. Taxact Chapter 4 of Publication 535 explains mortgage interest in detail. Taxact Expenses paid to obtain a mortgage. Taxact Certain expenses you pay to obtain a mortgage on your rental property cannot be deducted as interest. Taxact These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses that are part of your basis in the property. Taxact Form 1098, Mortgage Interest Statement. Taxact If you paid $600 or more of mortgage interest on your rental property to any one person, you should receive a Form 1098 or similar statement showing the interest you paid for the year. Taxact If you and at least one other person (other than your spouse if you file a joint return) were liable for, and paid interest on, the mortgage, and the other person received the Form 1098, report your share of the interest on Schedule E (Form 1040), line 13. Taxact Attach a statement to your return showing the name and address of the other person. Taxact On the dotted line next to line 13, enter “See attached. Taxact ” Legal and other professional fees. Taxact You can deduct, as a rental expense, legal and other professional expenses such as tax return preparation fees you paid to prepare Schedule E, Part I. Taxact For example, on your 2013 Schedule E you can deduct fees paid in 2013 to prepare Part I of your 2012 Schedule E. Taxact You can also deduct, as a rental expense, any expense (other than federal taxes and penalties) you paid to resolve a tax underpayment related to your rental activities. Taxact Local benefit taxes. Taxact In most cases, you cannot deduct charges for local benefits that increase the value of your property, such as charges for putting in streets, sidewalks, or water and sewer systems. Taxact These charges are nondepreciable capital expenditures and must be added to the basis of your property. Taxact However, you can deduct local benefit taxes that are for maintaining, repairing, or paying interest charges for the benefits. Taxact Local transportation expenses. Taxact You may be able to deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property. Taxact However, transportation expenses incurred to travel between your home and a rental property generally constitute nondeductible commuting costs unless you use your home as your principal place of business. Taxact See Publication 587, Business Use of Your Home, for information on determining if your home office qualifies as a principal place of business. Taxact Generally, if you use your personal car, pickup truck, or light van for rental activities, you can deduct the expenses using one of two methods: actual expenses or the standard mileage rate. Taxact For 2013, the standard mileage rate for business use is 56. Taxact 5 cents per mile. Taxact For more information, see chapter 4 of Publication 463. Taxact To deduct car expenses under either method, you must keep records that follow the rules in chapter 5 of Publication 463. Taxact In addition, you must complete Form 4562, Part V, and attach it to your tax return. Taxact Pre-rental expenses. Taxact You can deduct your ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available for rent. Taxact Rental of equipment. Taxact You can deduct the rent you pay for equipment that you use for rental purposes. Taxact However, in some cases, lease contracts are actually purchase contracts. Taxact If so, you cannot deduct these payments. Taxact You can recover the cost of purchased equipment through depreciation. Taxact Rental of property. Taxact You can deduct the rent you pay for property that you use for rental purposes. Taxact If you buy a leasehold for rental purposes, you can deduct an equal part of the cost each year over the term of the lease. Taxact Travel expenses. Taxact You can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip is to collect rental income or to manage, conserve, or maintain your rental property. Taxact You must properly allocate your expenses between rental and nonrental activities. Taxact You cannot deduct the cost of traveling away from home if the primary purpose of the trip is to improve the property. Taxact The cost of improvements is recovered by taking depreciation. Taxact For information on travel expenses, see chapter 1 of Publication 463. Taxact To deduct travel expenses, you must keep records that follow the rules in chapter 5 of Publication 463. Taxact Uncollected rent. Taxact If you are a cash basis taxpayer, do not deduct uncollected rent. Taxact Because you have not included it in your income, it is not deductible. Taxact If you use an accrual method, report income when you earn it. Taxact If you are unable to collect the rent, you may be able to deduct it as a business bad debt. Taxact See chapter 10 of Publication 535 for more information about business bad debts. Taxact Vacant rental property. Taxact If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining the property while the property is vacant. Taxact However, you cannot deduct any loss of rental income for the period the property is vacant. Taxact Vacant while listed for sale. Taxact If you sell property you held for rental purposes, you can deduct the ordinary and necessary expenses for managing, conserving, or maintaining the property until it is sold. Taxact If the property is not held out and available for rent while listed for sale, the expenses are not deductible rental expenses. Taxact Points The term “points” is often used to describe some of the charges paid, or treated as paid, by a borrower to take out a loan or a mortgage. Taxact These charges are also called loan origination fees, maximum loan charges, or premium charges. Taxact Any of these charges (points) that are solely for the use of money are interest. Taxact Because points are prepaid interest, you generally cannot deduct the full amount in the year paid, but must deduct the interest over the term of the loan. Taxact The method used to figure the amount of points you can deduct each year follows the original issue discount (OID) rules. Taxact In this case, points are equivalent to OID, which is the difference between: The amount borrowed (redemption price at maturity, or principal) and The proceeds (issue price). Taxact The first step is to determine whether your total OID (which you may have on bonds or other investments in addition to the mortgage loan), including the OID resulting from the points, is insignificant or de minimis. Taxact If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct. Taxact De minimis OID. Taxact The OID is de minimis if it is less than one-fourth of 1% (. Taxact 0025) of the stated redemption price at maturity (principal amount of the loan) multiplied by the number of full years from the date of original issue to maturity (term of the loan). Taxact If the OID is de minimis, you can choose one of the following ways to figure the amount of points you can deduct each year. Taxact On a constant-yield basis over the term of the loan. Taxact On a straight line basis over the term of the loan. Taxact In proportion to stated interest payments. Taxact In its entirety at maturity of the loan. Taxact You make this choice by deducting the OID (points) in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued. Taxact Example. Taxact Carol Madison took out a $100,000 mortgage loan on January 1, 2013, to buy a house she will use as a rental during 2013. Taxact The loan is to be repaid over 30 years. Taxact During 2013, Carol paid $10,000 of mortgage interest (stated interest) to the lender. Taxact When the loan was made, she paid $1,500 in points to the lender. Taxact The points reduced the principal amount of the loan from $100,000 to $98,500, resulting in $1,500 of OID. Taxact Carol determines that the points (OID) she paid are de minimis based on the following computation. Taxact Redemption price at maturity (principal amount of the loan) $100,000 Multiplied by: The term of the loan in complete years ×30 Multiplied by ×. Taxact 0025 De minimis amount $7,500 The points (OID) she paid ($1,500) are less than the de minimis amount ($7,500). Taxact Therefore, Carol has de minimis OID and she can choose one of the four ways discussed earlier to figure the amount she can deduct each year. Taxact Under the straight line method, she can deduct $50 each year for 30 years. Taxact Constant-yield method. Taxact If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. Taxact You figure your deduction for the first year in the following manner. Taxact Determine the issue price of the loan. Taxact If you paid points on the loan, the issue price generally is the difference between the principal and the points. Taxact Multiply the result in (1) by the yield to maturity (defined later). Taxact Subtract any qualified stated interest payments (defined later) from the result in (2). Taxact This is the OID you can deduct in the first year. Taxact Yield to maturity (YTM). Taxact This rate is generally shown in the literature you receive from your lender. Taxact If you do not have this information, consult your lender or tax advisor. Taxact In general, the YTM is the discount rate that, when used in computing the present value of all principal and interest payments, produces an amount equal to the principal amount of the loan. Taxact Qualified stated interest (QSI). Taxact In general, this is the stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a fixed rate. Taxact Example—Year 1. Taxact The facts are the same as in the previous example. Taxact The yield to maturity on Carol's loan is 10. Taxact 2467%, compounded annually. Taxact She figured the amount of points (OID) she could deduct in 2013 as follows. Taxact Principal amount of the loan $100,000 Minus: Points (OID) –1,500 Issue price of the loan $98,500 Multiplied by: YTM × . Taxact 102467 Total 10,093 Minus: QSI –10,000 Points (OID) deductible in 2013 $93 To figure your deduction in any subsequent year, you start with the adjusted issue price. Taxact To get the adjusted issue price, add to the issue price figured in Year 1 any OID previously deducted. Taxact Then follow steps (2) and (3), earlier. Taxact Example—Year 2. Taxact Carol figured the deduction for 2014 as follows. Taxact Issue price $98,500 Plus: Points (OID) deducted in 2013 +93 Adjusted issue price $98,593 Multiplied by: YTM × . Taxact 102467 Total 10,103 Minus: QSI –10,000 Points (OID) deductible in 2014 $103 Loan or mortgage ends. Taxact If your loan or mortgage ends, you may be able to deduct any remaining points (OID) in the tax year in which the loan or mortgage ends. Taxact A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. Taxact However, if the refinancing is with the same lender, the remaining points (OID) generally are not deductible in the year in which the refinancing occurs, but may be deductible over the term of the new mortgage or loan. Taxact Points when loan refinance is more than the previous outstanding balance. Taxact When you refinance a rental property for more than the previous outstanding balance, the portion of the points allocable to loan proceeds not related to rental use generally cannot be deducted as a rental expense. Taxact For example, if an individual refinanced a loan with a balance of $100,000, the amount of the new loan was $120,000, and the taxpayer used $20,000 to purchase a car, points allocable to the $20,000 would be treated as nondeductible personal interest. Taxact Repairs and Improvements Generally, an expense for repairing or maintaining your rental property may be deducted if you are not required to capitalize the expense. Taxact Improvements. Taxact You must capitalize any expense you pay to improve your rental property. Taxact An expense is for an improvement if it results in a betterment to your property, restores your property, or adapts your property to a new or different use. Taxact Betterments. Taxact Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property. Taxact Restoration. Taxact Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition. Taxact Adaptation. Taxact Expenses that may be for adaptation include expenses for altering your property to a use that is not consistent with the intended ordinary use of your property when you began renting the property. Taxact Separate the costs of repairs and improvements, and keep accurate records. Taxact You will need to know the cost of improvements when you sell or depreciate your property. Taxact The expenses you capitalize for improving your property can generally be depreciated as if the improvement were separate property. Taxact Table 1-1. Taxact Examples of Improvements Additions Bedroom Bathroom Deck Garage Porch Patio Lawn & Grounds Landscaping Driveway Walkway Fence Retaining wall Sprinkler system Swimming pool Miscellaneous Storm windows, doors New roof Central vacuum Wiring upgrades Satellite dish Security system Heating & Air Conditioning Heating system Central air conditioning Furnace Duct work Central humidifier Filtration system Plumbing Septic system Water heater Soft water system Filtration system Interior Improvements Built-in appliances Kitchen modernization Flooring Wall-to-wall carpeting Insulation Attic Walls, floor Pipes, duct work Prev Up Next Home More Online Publications
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