Owning a rental property is an effective way to generate a secondary income. When managed correctly, rental properties can generate consistent monthly cash flow while appreciating in value over time.
Although income earned from a rental property ownership might be a little different from income earned in a typical job, you can expect both kinds of income to eventually be taxed.
For most people who own a rental property, it will be necessary to file a Schedule E tax form every year. Even if their property has been operating at a loss, this is an essential tax form that should not be ignored.
In this article, we will discuss the most important things to know about a Schedule E tax form, including what it is, who needs to file it and everything else you might need to know.
What Is a Schedule E?
Schedule E is a supplementary tax form that is used to report any passive income or losses generated from rental properties and other types of supplementary income.
Generally speaking, the IRS wants to be aware of all types of income you earn over the course of the year. This means that even if your “rental property” is as simple as a spare room in your house that was rented for just a few nights, you’ll likely still need to file a Schedule E.
Schedule E is one of several different “schedules” the IRS uses for people to report income that wasn’t captured on any other forms. For individuals, Schedule E will supplement their original 1040 tax form. For partnerships and S corporations, Schedule E will supplement their original Form 8825.
Why Is a Schedule E Form Important?
With the rental property market expanding and more people exploring various types of real estate investments, Schedule E has become a very important tax document. The form itself – which contains space for up to three properties – is a single page, meaning learning how to file Schedule E is relatively easy.
However, if you have never filed rental property taxes before or are uncomfortable filing taxes on your own, you may want to consider working with a tax attorney or an accountant.
Who Should File a Schedule E With Rental Income?
Contrary to what many people assume, the IRS does not allow you to simply add your supplementary income on the base 1040 or W-2 forms you already filed. Passive income generated from rental properties is viewed as a legally distinct type of income, which is why a supplementary tax document needs to be filed.
However, keep in mind that this income needs to be authentically passive, rather than active (which will require a Schedule C instead).
The broad group of Schedule E filers includes:
- Ordinary rental properties, such as those with a 12-month lease
- Short-term and vacation rental owners, including people who own Airbnbs, Vrbos and other common short-term rental properties
- Rentals that are owned via partnerships, S corporations and various other formal business structures
Nearly everyone who generates passive income from a rental property or similar sources will need to file a Schedule E. It doesn’t matter how many rental properties you own, how much money each of these properties has made (or lost) or where in the country the properties are located – as long as these properties are generating cash flows and expenses, a Schedule E will need to be filed.
How Does Schedule E Work?
Before filing a Schedule E, you’ll need to determine whether or not your property qualifies as a Schedule E rental property. The IRS recognizes that this form should be used to “report income or loss from rental real estate, royalties, partnerships, S-corporations, estates, trusts and residual interests in REMICs.”
If your income is related to any of these categories, then a Schedule E might be required. Even if you use the property for personal use – such as your current home or a vacation home – as long as you are generating income, that income will need to be reported.
Active income vs. Passive income
Before filing a Schedule E, it’s very important to identify whether your participation in the ownership of the rental property is passive or active.
If all you do is put money into the property and leave day-to-day management to someone else, your participation is probably passive.
The IRS considers someone to be an active participant if their involvement in operating the property is “regular,” “substantial” and “continuous.” Of course, all of these loosely defined words leave room for interpretation.
But if you are directly managing the property, interacting with clients and providing additional services, your participation will likely be considered active by the IRS. In this case, you’ll usually need to file a supplementary Schedule C tax form, rather than a Schedule E.
Schedule E vs. Schedule C
One common area of confusion for rental property owners is whether they need to file Schedule E or Schedule C. Schedule C is used for sole proprietors and those who are filing for self-employment taxes. Both of these forms could apply, depending on the services being provided, causing rental property owners to question which one makes the most sense.
Generally, Schedule E is used by rental property owners who do not provide additional services to their tenants, while Schedule C is used by those who do. In other words, Schedule E is for income that is considered passive. Schedule C, in this case, is for business income, which is considered active income.
Passive property owners can still provide some basic “services” to their tenants, such as in-house electricity, heating, water and other essential needs. But if the property owner provides “substantial services” beyond what is considered normal for a rental property, this will be treated as business income, which is subject to a self-employment tax.
In this case, a Schedule C will need to be filed. This can include services such as laundry or cleaning services, Airbnb expenses, food delivery or catering, transportation services and more.
How Do You File a Schedule E Form?
It’s important to remember that a Schedule E form is a supplementary tax form and not a “stand-alone” tax form. So if you earned any additional income beyond your rental properties, you will need to begin by filing at least one other form.
File your 1040
For individual taxpayers, the tax form that needs to be filed prior to filing a Schedule E will be IRS Form 1040. This federal income tax form, along with its supplementary schedules, helps the IRS determine how much money you earned in a given year, which will ultimately influence your final taxes owed.
Determine your rental income
Once you have filled out your initial tax form, you will then need to determine your rental property’s total return for the year.
The income generated from your rental properties will equal your revenue minus all applicable expenses. Finding your revenue is usually pretty easy – all you need to do is look at how much money you collected in rent(s) throughout the tax year. Identifying expenses can be a bit more difficult.
Most property-related expenses can be deducted, including depreciation, interest, management fees, your property tax bill and others. The form will contain several lines that include common expenses. However, some expenses (such as minor upgrades for your own living space) might not be deductible.
File your Schedule E
After you have reported all relevant sources of revenue and expenses, you’ll have to fill out a few other boxes before your filing is complete.
Currently, Schedule E has enough room to report income generated from three rental properties. So if you own more than that, you’ll need to file multiple Schedule E forms. For partnerships and S corporations who have invested in rental properties, Schedule E will supplement Form 8825 instead.
Keep in mind, depending on the rental income and whether you are up to date with your taxes, the IRS might ask you to make an additional tax payment.
When In Doubt, Ask a Tax Professional
Compared to many other tax forms, filing a Schedule E is relatively straightforward. However, that doesn’t mean doing so will always be easy. The IRS is notoriously ambiguous with instructions – such as determining whether your participation is “substantial” – and if you have never filed a Schedule E before, you probably have a lot of questions.
Though paying for a tax professional might not be ideal, it can be very beneficial when dealing with complex tax situations (basically, anything involving supplementary forms).
Failing to do your taxes correctly, pay your taxes owed in full or file your taxes on time can result in fines and penalties that are much higher than the cost of a tax accountant. There’s nothing wrong with asking for help.
Also, you can write off your tax preparation fee as a tax deduction on next year’s tax return.