Rental Property

Rental PropertyOwning and renting property is common for many individuals. While the rental income and/or capital gains from owned property can be a financially rewarding endeavor, the IRS rules and regulations can be very complex.

This Rental Income brochure summarizes the most common forms of rental income, allowable expenses and their tax treatment.

The Rental Property Tracking Worksheet should help you document your rental income and identify deductible expenses from rental activities.

Rental Property Tax Law

Special tax laws have been created within the Tax Code to address rental income and losses. Generally, rental income is deemed "Passive" income within the IRS. This is done to distinguish rental income from "Earned" or "Ordinary" income like your salary or wages. This "passive" activity requires separate tax forms be filed and it limits your ability to net losses on rental activity against other types of income like your wages. On the other hand, "Passive" income is not subject to employment taxes (Social Security and Medicare). However, not all rental activity must by its nature be passive. Exceptions are renting vacation property and rental activity in which you are actively involved. The rules are complex, so it is always a good idea to discuss your situation.

Rental Income

What is Rental Income?

Rental income is any amount of money you receive or accrue as payment for the use of property. You must include:

What isn't Rental Income?

There are some forms of income from rental property that may be excluded such as:

Rental Expenses

Rental expenses directly related to the property that produces rent income are deductible from gross rental income to derive your adjusted gross rental income. Use the worksheet on the reverse side to assist you in identifying, tracking and documenting your gross rental income, deductions and adjusted gross income.

Other Rental Activity

Vacation Home Rental

Owning a vacation home can bring tax advantages for you, but the rules can be a little complex depending on the amount of personal and rental use of your home. It is best to review your vacation home plans on a regular basis to help maximize your tax advantages. Briefly, the rules are:

Rental of Personal Property

If you rent personal (non-real estate) property through a trade or business:

If you rent personal property along with the rental of real estate the personal property rent is not subject to the self-employment tax. Other rent income excluded from the self-employment tax are:

In these cases rent income is reported as Other Income.

Selling Your Rental Property

Any time you sell property you are required to calculate the gain or loss on the sale for tax purposes. When you sell property that you have rented, even if only part of the property was rented, the calculation of gain or loss becomes more complicated. Any depreciation taken on the property must be accounted for when determining the actual gain or loss. For instance, assume you sell a condo for $200,000 that you bought for $100,000; also assume you have rented the condo and depreciated $10,000 of the cost on your rental tax filings. Your taxable gain on the sale would be $110,000 ($200,000 minus $100,000 cost plus the $10,000 depreciation). Fortunately, long term capital gain tax rates are lower than in the past, but this depreciation recapture can be quite a tax surprise.

This publication provides only summary information regarding the subject matter contained here. Please call with any questions on how this information may affect your situation.

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Rental PropertyBeing self-employed can bring individuals great rewards and freedoms, yet it also brings great responsibility to ensure you comply with the rules and requirements of the IRS.

Are You Self-employed?

You are considered self-employed and subject to self-employment tax laws if you:

Self-Employment Tax

All self-employed must pay a self-employment tax in addition to income tax. The tax is 15.3% of net earnings and has two components; a 12.4% old age, survivors and disability insurance (OASDI) tax and a 2.9% component for hospital insurance (Medicare). The 12.4% OASDI portion is paid on net income (revenues less expenses) up to a set amount similar to social security. The 2.9% Medicare tax is paid on all net income. If you receive any wage income on which Social Security or Railroad Retirement taxes were paid then the self-employment tax income maximum is reduced by the amount of wages received. If self-employment income is below $400 no self-employment tax is due.

What is Self-employment Income?

What's Not Self-employment Income?

Self-Employment Tax Traps

Each year the Treasury Department (IRS) publishes statistics on the types of returns that get audited and those returns with self-employment income are always at the top of the list.

To reduce your chances of an unexpected tax bill:


One of the biggest tax advantages for self-employed is the ability to deduct your business expenses directly against your income- regardless of whether you itemize your deductions. You are not subject to the 2% of adjusted gross income threshold that applies to an employee's out-of-pocket business related expenses. As a self-employed individual, your business expenses reduce the amount of your income that is subject to the self-employment tax (FICA) while the unreimbursed business expenses of an employee do nothing to reduce their FICA tax.

Self-employed Health Insurance

Another major tax deduction provided by the IRS to the self-employed is the ability to deduct a large portion of your medical insurance costs. Under certain circumstances, if you hire your spouse as a bonafide employee and provide health insurance, 100% of the cost of the insurance may be deductible. Similarly, a written self-insured medical reimbursement plan may be a 100% deductible expense and enable you to provide tax free reimbursement of uninsured medical costs to employees for things like co-payments, prescriptions, vision and dental care.

Domestic Production Activity Deduction (DPAD)

Beginning in 2005, there is a special deduction on page one of Form 1040 for qualified domestic production activities. The deduction is 3 to 9% of net qualified income (limited to 50% of W-2 wages). If you manufacture product, grow crops or process tangible personal property your business may qualify. Common businesses include: farming, ranches, film/music/software development, construction, engineering and architectural services.

This publication provides only summary information regarding the subject matter contained here. Please call with any questions on how this information may affect your situation.

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Home Office

Rental PropertyToday, more and more people are working from their homes. This is readily made possible due to technological advances such as the computer, cell phones, internet and e-mail. If you are running a business out of your home or thinking about starting an in-home business, the information in this brochure should be helpful in detailing when and how you can claim the tax deductions available to you.

Home Office Guidelines

Under liberalized guidelines for Home Office Deductions more people are eligible to deduct home office expenses. The rules allow workers such as plumbers, contractors and consultants, who primarily perform services away from home, to deduct their home office expenses. Prior to 1997 it was very difficult for home-based workers whose jobs routinely took them out of their homes to qualify for home office expense deductions.
While more details will follow, generally:

Deductibility Requirements

Not sure whether you can deduct your home office expense? You may deduct home office expenses if you meet these tests.

On-going Trade or Business Test

If the space is used in a trade or business on a regular and continuing basis:

Importantly, you must present sufficient evidence to convince the IRS that business was conducted on a regular basis.

Tip: Management by an individual of his/her investment portfolio is not considered a trade or business.

Exclusive Use Test

Caution: If the space must be used to store inventory, the cost of storage space for books, files or equipment cannot be deducted unless you qualify under one of the following tests:
  • the space is used for storage of product samples, thus you need not attempt to distinguish between inventory and product samples.
  • the space is used as a Daycare Facility, provided you comply with all state approval requirements and you are in the business of providing day care for children, persons 65 or older or persons who are physically of mentally unable to care for themselves.

Separate Structures Test

Place to Meet Patients, Clients or Customers

Principal Place of Business Test


Note: The Supreme Court has held that the principal place of business is a subjective process that must be made on the facts of each case by comparing two primary factors:

  1. The relative importance of the business activities performed at each location; and,
  2. The time spent working at each place

One's best bet to insure the home office deduction without IRS challenge is to :

Administrative and Management Activities Test

Tax Relief Act of 1997 liberalizes home office use by retaining all of the pre-established conditions (e.g. regular and exclusive use, storage of inventory and samples, separate structure, a place to meet patients, clients, or customers) but adds that a home office also qualifies as a principal place of business if:

Therefore, a home office deduction is allowed if a portion of the home is exclusively and regularly used to conduct administrative or management activities as long as you don't perform these duties at another location even though some administrative and management activities may be conducted by someone else at another location. This home office deduction is allowable even if you perform administrative or management activities outside the home in a non-fixed location (e.g. auto or hotel room) or if in another fixed location, the administrative or management activities are not substantial. This liberalization of home office deductibility benefits:

Tip: Commuting costs may be a deductible business travel expense if the principal place of business becomes your home office.

If you are an employee

A home office deduction may be possible if:

Figuring the Business Deduction

Caution: If the business is active less than a full year consider the time period in business for which the deduction is allowed.

This publication provides only summary information regarding the subject matter contained here. Please call with any questions on how this information may affect your situation.

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Clergy and Non-Profits

Rental Property


Members of the clergy are in many ways treated like non-clergy taxpayers, but there are special tax treatments that recognize their position as members of a church.


General Rules of Income - for all taxpayers

U.S individual taxpayers are required to report as gross income all compensation for personal services in the year they receive it, no matter what the form of payment. This includes:

In addition to the guidelines above, Clergy must report compensation such as:

Employee or Self-employed?

For tax purposes, members of the clergy may be treated as either employees (preferred by the IRS) or independent contractors. In either case, with approval from the IRS, clergy may decide to be made exempt from self-employment (Social Security and Medicare) taxes. If an exemption is claimed, no benefits are available to the clergy member under either program in retirement. So unlike other taxpayers who are required to pay Social Security and Medicare, clergy may choose whether or not to participate.

As an Employee:

As an Independent Contractor:

Fringe Benefits

Fringe benefits given to clergy do not have to be included as income provided the clergy does not utilize them for personal use. If used for personal use, you must calculate the value of the percentage of your personal use. Such fringe benefits could be:

Caution: Housing provided or a housing allowance paid to a member of the clergy for teaching or administrative services by a non-church affiliated college, university or other institution may not be excluded from income.

Tip: Have your church adopt an accountable business expense reimbursement plan. Without one, unreimbursed business expenses are only deductible in excess of 2% of your income and are limited on a pro-rata basis to the extent of any housing allowance received (Deacon Rule).

Accident and Health Plans

Ministers do not have to include as income the amount their church or religious organization pays for accident and health insurance on their behalf. This includes most reimbursements for out of pocket medical treatment or disability income.

Retirement Plans-403(b)s

Many religious, charitable, educational and public non-profit organizations offer deferred compensation retirement savings plans. These are commonly called 403(b) plans and are usually funded through the purchase of annuities or custodial accounts comprised of mutual funds.

Contributions made to qualified retirement plans of a church or religious organization:

Tip: Contributions made for a self-employed minister to a qualified retirement plan of a church or religious organization may be excluded from income.

Common Mistakes

Mortgage Interest

A minister is allowed to deduct mortgage interest and real estate taxes paid for a personal residence even if the funds paid are from a rental/housing allowance that is exempt from income tax.

Self-employment Tax

Duly ordained members of the clergy who have taken vows of poverty are not subject to the self-employment tax when they perform duties connected with their religious order.

Employees of a church electing exemption from Social Security Withholdings are considered self-employed and subject to the self-employment tax if their church income is more than $108.00.

This is a tax trap for many church employees whose wages are subject to the full 15.3% self-employment tax.

Withholding on Salary and Wages

Wages and salaries paid to members of a religious order for services performed for the order or any associated institution are exempt from mandatory withholdings.

Caution: Check whether tax withholdings are taken from your pay. It's voluntary. If not, you could be in for a big tax at the end of the year and possible penalties if you should fail to make quarterly estimated tax payments.


Typically non-profit organizations are classified as tax-exempt charitable organizations under IRS code section 501(c)(3). They are organized for charitable purposes or for the mutual benefit of their members. Examples of such organizations include: charities, charitable trusts, professional associations, private foundations, local YMCAs, neighborhood churches and other religious groups and co-ops. Any net income directly related to their purposes are not taxed and may be retained by the organization for future operational needs.

Tax-exempt Status

Tax-exempt status must be applied for by filing Form 1023, 1024 or, in the case of a private foundation, Form 990PF. Although not taxed, these groups must file an informational return each year.

Public Disclosure

All non-profit tax-exempt organizations are required to allow public examination of their application for tax-exempt status and disclose their most recent informational returns.

Income Rules

Tax-exempt Income

The more common types of tax-exempt income include:

Taxable Income

Non-profits may earn unrelated taxable income from business activities. Any non-related business income must be filed on a taxable return (Form 990-T). This includes:

Losses where there is no profit motive may not be used to reduce income from any taxable activities.

Caution: With taxable income, non-profits are treated and taxed like corporations and are expected to pay quarterly estimated taxes.

Employee Income

Most employees of non-profit organizations, unless officially ordained ministers and/or religious clergy, must pay income tax on their wages, salaries and other forms of compensation.

This publication provides only summary information regarding the subject matter contained here. Please call with any questions on how this information may affect your situation.

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Health Care Professionals

Rental PropertyThis brochure is designed to provide income tax information specifically pertinent to individuals who work in health care professions.

While in many ways the IRS treats health care professionals just as they treat taxpayers in other fields of employment, there are some special tax treatments and deductions worth discussing.


Most health care professionals fall into two income earning groups. Either you are an employee or you are considered self-employed. Some individuals actually earn income as both an employee and as a self-employed individual.

Employee or Self-employed?

For tax purposes, workers in health care will be treated as either employees or as self-employed unless you work on a volunteer basis.

As an Employee:

Tip: Any excess expenses above your reimbursements may be an itemized deduction if they exceed 2% of your income.

As self-employed:

Excludable income to employees

Excludable Research Income

Income received for research may be exempt from income tax by health care facilities in several areas:

Allowable Deductions For Self-Employed

In addition to the typical deductions allowed for non-reimbursable expenses incurred by employees and business expenses of self-employed, health care professionals who are not employees may deduct the following expenses to the extent they are directly related to the practice of their profession such as:

Deductible Expenses as an Employee

If you are a health care professional who is an employee you may deduct non-reimbursed business expenses in excess of 2% of your adjusted gross income (AGI). Typical expenses include:

Reduced Deductions for High Incomes

Health care professionals with individual incomes over a certain adjusted gross income (AGI) threshold must reduce their allowable itemized deductions by 3% of the excess amount over the threshold times 1/3. No reduction is required for:

Note: The reduction can never be more than 53.3% of your itemized deductions. The reduction is applied after the disallowance of miscellaneous expenses below 2% of your income.

Non-deductible Expenses

Office in Your Home

Many health care professionals can now enjoy the tax benefits of deducting the cost of an in-home office. If you are a health care professional with an office in your home, you may deduct certain expenses if:

The tax laws regarding home office use have recently been relaxed. With the new home office definition, many professionals who perform administrative duties in their home can now take home office deductions.

Cash vs. Accrual Method of Accounting

Most professional medical service businesses have traditionally used the Cash Method of accounting for keeping their books, preparing financial statements and filing annual tax returns. This method allows revenue, or income for services, to be recorded when payment is received, not when the payment obligation is established at time of the service. This cash basis method may not apply appropriately if you are selling any medical supplies, equipment, medications or supplements in your practice. When you have an inventory of purchased items that are sold later, the Accrual Method of accounting may be required. Combination methods of cash and accrual are also possible. Call if you would like clarification regarding your situation.

Tip: If your average gross revenues for the past three tax years is less than $1 Million, you can use the cash method of accounting, despite the fact that there is inventory present.

Cooperative Hospital Service Organizations

The IRS provides tax exempt charitable organization status to cooperative hospital service organizations who perform the following types of services to two or more tax-exempt (non-profit) hospitals including those hospitals owned and operated by the local, state or federal government:

With this status an informational return is filed, but charitable rules of taxation apply.

This publication provides only summary information regarding the subject matter contained here. Please call with any questions on how this information may affect your situation.

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Educators & Day Care Providers

Rental PropertyThis provides an overview of the deductions that may be allowable to educators and those studying to become educators. While in most cases the IRS treats educators like other taxpayers, there are some distinct tax benefits extended to those in teaching.


Income in the form of salary and wages to educators who are employed by any public or private educational institution, medical teaching facility or community school district is generally taxable and subject to Social Security and Medicare tax.
Other common non-salary earned income and compensation may be classified as self-employed income. This income is not only subject to income tax, but also may be subject to a 15.3% self employment tax. Withholdings are rarely taken out of this self-employed income and quarterly estimated taxes should be paid for federal, state and self employment tax obligations.

Examples of typical self-employed educator income are:

Excludable Income

Some forms of compensation to educators may be excluded from income. They include:

Caution: Payments to individuals who teach or conduct research as part of their degree curriculum are not excludable from gross income and may be taxed.

Tip: Tax laws are liberalized regarding employer-provided meals. If provided for the convenience of the employer, they are not only excludable from income for teachers, but 100% (formerly only 50%) deductible for the educational institution.


Deductible Expenses

A common mistake made by teachers is not keeping track of out-of-pocket expenses, including mileage deductions. How often have you purchased supplies for your classroom which were not reimbursed? Some of the most common deductible expenses include:

Also remember mileage, meals, and travel expenses. Mileage can be deducted whenever you go to or from your place of work from a non-home location or to another job.
Unfortunately, these expenses for salaried teachers are considered itemized deductions allowable only in excess of 2% of your income when combined with other expenses, but if you are treated as a self-employed contractor you may deduct 100% of such costs as business expenses.

Tip: Through 2007 (and potentially 2008 pending legislative action) up to $250 spent for out-of-pocket purchases of classroom materials may be deducted without itemizing. To qualify you must be a full-time K-12 educator. What can you do with excess expenses subject to a 2% of income threshold as a misc. itemized deduction? Donate! Collect your receipts, fill out a non-cash donation form and have your school acknowledge you donated the items to the school. If done properly, it reclassifies your expense as a charitable donation and avoids the 2% misc. deduction income threshold rule.

Tip: How can you tell whether you are considered an employee or self-employed? If you receive a W-2 they consider you an employee. If you receive a 1099 you are being viewed as a contractor (self-employed).

Non-deductible Expenses

Tip: Technical manuals and books with permanent value are considered capital expenditures that must be depreciated over their useful life, not fully deductible in the year purchased.

Home Office

Rules may enable a deduction for use of your home as an office if the area in your home is:

This break is especially good for those who teach out of their home, such as tutors and music teachers.

Caution: The rules for business use of your home can be very complex and are highly scrutinized by the IRS. It's wise to seek advice on your particular situation.

Day Care Providers

As a subset of educators, day care providers warrant discussion regarding income, deduction of business expenses and the business use of your home.

First, you need to consider how you are viewed in the eyes of the IRS for your day care activity.

It is important to know how you are viewed in the eyes of the IRS to take full advantage of your tax situation.


If you are an independent day care provider or contract labor, your income is typically self employed income and must be reported on a schedule C with your 1040 return. Your customers (parents) do not withhold any social security, federal or state taxes, so you are responsible to pay quarterly estimated taxes for your state, federal and self-employment tax (15.3%) obligations.
Conversely if you are an "employee", half of the self-employment tax is paid by the day care. Your share (7.65%) is withheld from your pay for social security and medicare.

Allowable Deductions

You may deduct your day care business related expenses and your use of your personal residence to provide day care services to children, elderly or handicapped if:

Tip: It is recommended that a separate checking account be used to keep your day care expenses separate from other expenses.

A check list of the most common expenses includes:

Home Based Day Care Deductions

Common day care business-use-of-home deductions are calculated on the percentage of your home that is used for the day care services and include that portion of:

Note: Family (home-based) day care providers can use standard meal and snack rates versus actual costs in deducting meal and snack expenses for eligible children.
Business use of home expense calculations can be tricky. Call with questions particular to your situation.

This publication provides only summary information regarding the subject matter contained here. Please call with any questions on how this information may affect your situation.

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