IRS Publication 527 Rental Property

Do you own a second house that you use for rental income? Even if that home is just a part-time rental, like perhaps a vacation home, many people believe that the US tax code requires them to report all rental income that is received. This is generally true, but there are some differences in the expenses of a second home that can be deducted and rental activity needs to be covered in a specific way. If you use the property as a rental, this effectively makes it a business asset. This requires a different disposition of assets.

IRS Publication 527 is 5 chapters of tax instructions that cover everything you need to know about this second home. It includes special rental situations that include non-profit rental activities, the actual expenses and deductions you can take, and what the limits are to depreciation.

Why Is This Information Important?

When it comes to the care of a rental property, many landlords include a stipulation in their lease that any damage must be 100% replaced with a new item. The only problem is that because this home is a business asset, it will depreciate over time. This means that certain items within the home could be considered worthless and require replacement after a period of time.

For example: a rental home that is 20 years old still has its original carpeting. Upon moving out, the landlord discovers that the carpet has a permanent round circle in it from an office chair that was placed upon it. The landlord registers this as damage and charges the tenant the complete cost of replacing the carpet for the entire room.

The only problem is that the carpet has a depreciation of 7-10 years in most instances – even if that depreciation has not been claimed on taxes. This means the carpet is 10 years past being worth $0 and so the landlord has no legal right to charge the tenant for the cost of the product repair because it was past its expected lifespan. Cleaning that carpet? Not a problem – that's a legitimate charge. A full replacement on an old item? That can create a legal liability for the landlord.

It's Also About the Deductions You Can Take

Because a second home is treated as a business asset if it is being rented, it is often subject to the at-risk rules of an investment. You'll suffer full losses on the value of the asset if it declines and if you have an increase in value, then you'll be subject to the investment taxes that are applicable for any given year. This includes all rental real estate activities because these are considered passive activities.

This means you can't write off losses. If you can qualify as a real estate professional, however, then rental activities are no longer considered passive. To qualify, you must have worked more than 750 hours in the service of real property trades with other individuals or businesses and at least 50% of the personal services that you perform are in real property trades.

By knowing IRS Publication 527, you'll be able to maximize the profitability of your second home. Go through it in-depth before the next tax season starts so that you'll be prepared for any liabilities that may be required of you.
Posted on Sep 18, 2014


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