US rental property income tax

Simon Misiewicz

Expat & Property Tax Specialist

19th April 2022

US rental property income tax reported on your 1040 US expat tax return

American real estate property income is declared to the Inland Revenue Service (IRS) on Form 1040 for individuals and Form 1120 for corporation tax returns.

What are the basics of US rental property income tax?

As property accountants serving thousands of UK landlords that purchase buy to let properties, we know that the subject of US rental property income tax can be complex and daunting.

If you own rental real estate, it is vital to be aware of your federal tax responsibilities.

All rental income must be reported on your tax return, while associated expenses can be deducted from your rental income.

If you are a cash basis taxpayer, you report rental income on your expat 1040 tax return for the year you receive it. This is regardless of when it was earned.

As a cash basis taxpayer, you generally deduct your rental expenses in the year you pay them.

If you use an accrual method, you generally report US rental income when you earn it rather than when you receive it. You deduct your expenses when you incur them rather than when they were paid.

Most individuals use the cash method of accounting.

If you’re a private landlord with US rental property, you will usually count rent money as income in the relevant tax year.

How is US rental income classified on the IRS expat tax return?

US rental income is any payment you receive for the use or occupation of a property.

You must include all the amounts you receive as rent in your gross income.

You must report rental income for all your properties. US rental income in your ex-pat tax return is classified as any amount you receive before the period that it covers. This includes advance rent.

Include advance rent in your US rental income on an ex-pat tax return in the year you receive it regardless of the period covered or the method of accounting you use.

Security deposits used as a final payment of rent are considered advance rent, included in your income when you receive it. Do not include a security deposit in your rental income if you plan to return it to your tenant at the end of the lease.

If you keep part of or all of the security deposit during any year, include the amount you keep.

Property or services received instead of money as rent must be included as the fair market value of the property or services in your rental income.

What deductions and rental expenses are available?

You may deduct certain rental expenses on your 1040 expat tax return if you receive US rental income from real estate.

These expenses include mortgage interest, property tax, operating expenses, depreciation and repairs.

You can deduct the ordinary and necessary expenses for managing, conserving and maintaining your rental property.

Ordinary expenses are those that are common and generally accepted in the business.

Necessary expenses are deemed appropriate, such as interest, taxes, advertising, maintenance, utilities and insurance.

You can deduct the costs of certain materials, supplies, repairs, and maintenance that you make to your rental property to keep it in good operating condition.

You deduct US rental expenses paid by the tenant if the rent paid to you is reduced by the same amount.

You cannot deduct the cost of improvements.

A rental property is improved only if the amounts paid are for the betterment, restoration or adaptation.

The cost of improvements can be recovered through depreciation.

You can recover some or all of your improvements by using Form 4562 to report depreciation beginning in the year your rental property is first placed in service.

These costs include those incurred at the beginning of any year you make an improvement or add furnishings.

The IRS has provided clear guidance to ensure that you know the tax facts when renting residential property.

How do I report rental income and expenses to the IRS on my expat tax return?

If you rent out US real estate such as buildings, rooms or apartments, rental income and expenses are reported to The IRS on Form 1040 or 1040-SR, Schedule E, Part I on your US expat tax return.

List your total income, expenses, and depreciation for each rental property on the appropriate line of Schedule E on your 1040 expat tax return to be submitted to The IRS.

If you have more than three rental properties, complete and attach as many Schedule E forms as are needed to list the properties.

If your rental expenses exceed rental income, your loss may be limited.

The amount of loss you can deduct may be limited by the passive activity loss rules and the at-risk rules.

See Form 8582, Passive Activity Loss Limitations and Form 6918, At-Risk Limitations determines if your loss is limited.

If you have any personal use of a dwelling unit you rent (including a vacation home or a residence in which you rent a room), your rental expenses and loss may be limited.

Read this to find out everything you need to know about Form 1040.

How does the 1040 Schedule E US tax return affect an expat landlord in the States?

After gathering all of the necessary information, you will apply those pieces to Schedule E on your tax form. For this reason, Schedule E is a critical form for ex-pat property investors to get right.

You need to keep precise records of your property management to provide to the IRS.

This includes rent cheques, financial statements, receipts, and deductible expenses.

Good record-keeping throughout the year is essential for accurate US expat tax reporting of the transactions associated with rental properties.

Hiring a rental management company will help with your expat tax return filing to the IRS. You will be provided with an organised statement at the end of the year that lists your income and detailed expenses.

These management companies often charge a significant percentage of the gross income, so many expats opt to manage their property from abroad.

It is recommended that you maintain electronic records of all your transactions from the beginning of a business.

What records do USA property investors need to keep?

Good records will help monitor:

– the progress of your rental property

– prepare your financial statements

– identify the source of receipts

– keep track of deductible expenses

– prepare your tax returns and

– support items reported on tax returns.

Maintain good records relating to your rental activities, including the rental income and rental expenses.

You must be able to document this information if your tax return is selected for a possible IRS audit.

You must be able to substantiate certain elements of expenses to deduct them.

To support your expenses, you generally must have documentary evidence, such as receipts, cancelled cheques or bills.

Keep track of any travel expenses you incur for rental property repairs.

You need good records to prepare your tax returns.

These records must support the income and expenses you report.

Generally, these are the same records you use to monitor your real estate activity and prepare your financial statements.

Can I deduct rental expenses from my taxes?

You can deduct your expenses in the year you pay them.

You can deduct these and other less common expenses for your rental property:

– Advertising

– Auto and travel

– Cleaning and maintenance

– Commissions

– Insurance

– Legal & professional fees

– The mortgage interest paid to banks/financial institutions

– Repairs

– Real property taxes

– Utilities

– Depreciation expense

– Expenses specific to your rental such as landscaping costs

Expenses that are worth highlighting in greater detail here include:

Depreciation includes allowances for wear and tear, exhaustion (including obsolescence) or property. You begin to depreciate your rental property when you place it in service. You can recover some or all of your original acquisition cost and the cost of improvements to report depreciation at the beginning of the year your rental property is first placed in service.

– Repair Costs – expenses to keep your property in good working order but do not add to the property’s value.

– Operating Expenses – other expenses necessary for the operation of the rental property, such as the salaries of employees or fees charged by independent contractors (groundkeepers, bookkeepers, accountants and solicitors) for services provided.

US rental income reporting IRS Vs HMRC

We need to be mindful that British people owning property in the US may need to report the US rental income on their UK self-assessment tax return. There are certain deductions that you are not allowed to make on a UK self-assessment tax return for US rental income. Items being, depreciation is a significant cost, reducing your US ex-pat tax return profits but not allowed on your UK self-assessment. This could result in you paying more tax in the UK.

Please note that you will receive a tax credit in the UK or US, per the US/UK tax treaty, to prevent you from paying tax twice.

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