Guide to Schedule E Forms for Landlords

Posted in Blog on by

Active vs. Passive Income

First, let’s be clear on the difference between active and passive income according to the Internal Revenue Service. This is an important concept for landlords, who are responsible for documenting and reporting all of their rental income.

Active income (also known as earned income) is the result of business activities. Landlords and property managers operating as sole proprietors or LLCs generate active income. Active income is reported on a Schedule C, which is part of IRS Form 1040.

Passive income (also called supplemental income) does not come from any business activities. Passive income is reported on a Schedule E, also part of the 1040 form.

If you’re not certain, consult your accountant to determine whether you need to submit a Schedule C or a Schedule E form.

Searching for an experienced partner to manage your rental property? Palmetto State Properties is known for their ability to manage, market and maintain rental properties in the greater Charleston, SC area. Get in touch today. 

What Is Material Participation?

The broad definition of material participation in an income-producing activity is that the individual’s participation is regular, continuous, and substantial.

For a landlord’s income from a rental business to be considered active income, it must meet at least one of the seven “material participation” tests established by the IRS. This is an important distinction because only material participants in an income-producing activity are allowed to deduct the full amount of any business losses on their income tax returns. (The deductibility of passive losses is limited.)

The seven tests for material participation are:

  1. – Participation for more than 500 hours
  2. – Activity that constituted all participation substantially
  3. – Involvement for more than 100 hours and no less than the participation of any other individual
  4. – A significant participation activity (a business in which the individual participates, without meeting any of the other six tests for more than 100 hours), combined with all significant participation activities for more than 500 hours
  5. – Participation during any five of the preceding ten taxable years
  6. – A personal service activity (any activity in which capital is not a material income-producing factor, such as health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting), for any three prior taxable years
  7. – Partaking for more than 100 hours and based on all the facts and circumstances, on a regular, continuous, and substantial basis

How Is Schedule E Used?

Landlords use Schedule E forms used mainly to report passive income or loss from a rental business when they had no material participation in the rental activity. The form has several sections:

The first page (Part I) captures identifying information about the rental business, such as property types and locations, rental and personal use days per property, rents and royalties received for each property, expenses paid out per property in categories such as:

  • Advertising
  • Auto and travel expenses
  • Cleaning and maintenance
  • Commissions
  • Insurance
  • Legal and other professional fees
  • Management fees
  • Mortgage interest paid
  • Other interest paid
  • Repairs
  • Supplies
  • Taxes
  • Utilities
  • Depreciation expense or depletion
  • Other

The second page is used to document:

  • Income or Loss from Partnerships and S Corporations (Part II)
  • Income or Loss from Estates and Trusts (Part III)
  • Income or Loss from Real Estate Mortgage Investment Conduits (REMICS) (Part IV)
  • Summary, including real estate professional’s material participation in rental real estate (Part V)

What Help Is Available?

The IRS publishes detailed instructions for completing every part of a 1040 individual income tax return form. They also provide other publications explaining IRS rules, such as those regarding the deduction of losses from passive activity.

Your accountant is also a valuable resource because of their deep knowledge of your specific business situation and the details of your finances. And if you’re working with a property management firm, you may be able to arrange to have them document and manage all information needed to calculate a rental business loss or profit. Palmetto State Properties captures all expenses and includes an annual statement along with a 1099. We have more owner services to help you too!

Not every landlord can afford to keep a bookkeeper or accountant on the payroll. However, there are some very helpful landlord software packages that can save you a lot of time and effort, and can even auto-generate a report allocating actual expenses to Schedule E expense categories.

If you don’t prepare your own tax return, you can print out a Schedule E report and send it to your accountant or other tax preparer.

Final Note:

At this point, you should have a good idea as to whether you will need to report the income or loss from your rental business as passive (on a Schedule E) or active (on a Schedule C). But for landlords, tax preparation is more complicated than knowing which form to use. It’s more cost-effective to seek help on the front end than it is to find out that deductions have been disallowed and get shocked with an unexpectedly high tax bill.

Get in touch today to find out how we can help.

Archives