Taxation of rental income for US citizens
Published on January 03, 2024
by Rose-ann De Villa, EA, CPA
Rose-ann De Villa, an IRS Enrolled Agent and CPA with 13 years of expat tax experience, specializes in US tax preparation, tax planning, and tax advice for US citizens and Green Card holders living and working in the UK.
Rose-ann has been mentioned in the Daily Express UK news wherein she talked about Stimulus payments and Child Tax Credit refunds for US expats in the UK.
Table of Contents
How can I handle my rental income taxes in the US while I’m living in another country?
While you can file your tax returns yourself, including reporting rental income, managing this from abroad can be complex. Handling rental income taxes as a US expat requires staying informed about US tax laws and diligently keeping records of all income and expenses related to your rental property.
A tax professional’s expertise is invaluable. They can ensure that you are compliant with your tax responsibilities while maximizing any deductions you might have missed.
What is rental income taxation?
Rental income taxation refers to the tax obligations arising from earning income through renting out property. It encompasses the rent payments received, as well as any other payments like cancellation fees or paid utilities.
However, it’s important to note that expenses incurred in the process of renting out your property, such as maintenance, repairs, and property management fees, can often be deducted.
You may also be able to claim depreciation on the property, which can reduce your taxable income.
Who is required to report rental income?
- US Citizens, Residents, and Green Card Holders: All US citizens, residents, and Green Card Holders are required to report their global income, including rental income from properties located in other countries.
- Foreign Property Owners: If you own property in a foreign country and earn rental income from it, you must report this income in both the country where the property is located and on your US tax return.
When you’re in a foreign country, handling your rental income taxation can be complex. This is why consulting with a tax professional who specializes in expatriate tax issues is highly recommended. Their guidance is invaluable in managing your rental income effectively and staying compliant with tax laws.
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How is rental income classified?
- Monthly Rent Payments: Regular payments received from tenants for the use of your property.
- Advance Rent: Rent paid in advance, such as the first and last month’s rent upfront, is taxable when received.
- Security Deposits: Not typically taxable if intended to be returned to the tenant. However, if retained during the rental period, it becomes taxable income.
- Service Charges: Payments for services provided as part of the rental agreement, like utilities, are also considered rental income.
How do you calculate and report rental income and expenses?
Start by adding all the rental income received during the tax year. This includes monthly rent payments from tenants. Include any rent paid in advance, such as the first and last month’s rent if received in the tax year.
Add other income related to the rental property, such as fees for late rent payments, lease cancellation fees, or service charges for utilities if they are included in the rental agreement.
Once you’re done with that, you will want to look at your deductible expenses:
- Maintenance and Repairs: Sum up expenses for maintaining and repairing the property. This includes costs for labor and materials.
- Property Management Fees: If you use a property management company, include the fees paid to them.
- Mortgage Interest: Deduct the interest paid on a mortgage for the rental property.
- Insurance Premiums: Include premiums paid for property insurance.
- Depreciation: Calculate depreciation on the property’s value and improvements. This can be complex, as it involves spreading the cost over the property’s useful life as determined by IRS guidelines.
- Other Expenses: Include any other allowable expenses like legal fees, advertising costs, and travel expenses related to property management.
Now, you’ll need to deduct the total allowable expenses from your total rental income to determine your net rental income or loss.
We understand that this can be quite difficult and mind-numbing if you’re a US expat, which is why we recommend getting support from a tax professional. They can provide expert advice on current tax laws and allowable deductions, ensuring you don’t miss out on any potential
They can also assist in accurately calculating depreciation and other complex deductions, as well as ensure that all calculations comply with IRS regulations, reducing the risk of errors and potential audits.
You also won’t need to worry about preparing and filing your tax return.
While calculating and reporting rental income and expenses can be done independently, the expertise of a tax professional is invaluable, especially for US expats who might face additional complications in their tax situation.
When and how should you report rental income?
Rental income must be reported annually on your US tax return. The standard deadline for filing your US tax return is April 15th of the year following the tax year in question. For example, for the 2023 tax year, the filing deadline is April 15, 2024.
However, US citizens living abroad typically receive an automatic two-month extension to file their tax returns. This means the deadline for expats is generally June 15th. However, any taxes owed are still due by April 15th to avoid interest charges.
As a US expat, you should report your US-based rental income on your US tax return using Schedule E (Form 1040) or 1040-SR, Schedule E, Part I. This includes detailing all rental income received and allowable expenses incurred during the tax year.
What tax deductions and credits are available for rental properties?
Based on information from the official IRS website, here’s what US property owners need to know about rental property deductions:
Deductible Rental Expenses
- Mortgage Interest and Property Tax: These are common expenses that can be deducted on your tax return.
- Operating Expenses: General operating expenses for the property, such as utilities, insurance, and routine maintenance, are deductible.
- Depreciation: This allows for recovering the cost of the property over its useful life. It’s a significant deduction that can offset rental income.
- Repairs and Maintenance: Costs incurred to keep your property in good operating condition are deductible. This includes expenses for materials, supplies, and labor for repairs.
Ordinary and Necessary Expenses
- Common Business Expenses: Ordinary expenses, which are common and accepted in the rental business, are deductible.
- Appropriate Expenses: Necessary expenses, deemed appropriate for the property, such as advertising, are also deductible.
Tenant-Paid Expenses
- Deducting Tenant Expenses: If your tenant pays any rental expenses, these can be deducted. However, you must also include the fair market value of these expenses in your rental income.
Improvements vs. Repairs
- Improvements: The cost of improving your rental property is not immediately deductible. Instead, these costs are recovered through depreciation.
- Depreciation of Improvements: Use Form 4562 to report depreciation for improvements, starting from the year the property is placed in service or the year of improvement.
Depreciation Details
- Form 4562: This form is used to report depreciation, including for any improvements or added furnishings.
- Partial Deductions: Only a percentage of improvement expenses are deductible in the year they are incurred.
How does Passive Activity Loss (PAL) rules affect rental income?
The Passive Activity Loss (PAL) rules are designed to restrict the ability to offset income with losses from passive activities, which typically include rental activities.
This means that the losses from these activities can usually only offset income generated from other passive activities. The primary purpose of these rules is to prevent individuals from using passive losses to offset their regular income, such as wages or business income.
If you actively participate in your rental activity, the PAL rules allow a special allowance. It’s important to note that active participation requires involvement in meaningful management decisions like approving new tenants or deciding on rental terms.
Under this provision, you may be able to deduct up to $25,000 in losses against your other income.
Note that this $25,000 allowance begins to phase out for taxpayers with a modified adjusted gross income (MAGI) above $100,000 and is completely eliminated once MAGI reaches $150,000.
However, if you qualify as a real estate professional, the PAL rules do not apply to you in the same way. To qualify, you must spend more than half of your working hours and over 750 hours per year in real property businesses in which you materially participate.
Given the difficulties of the PAL rules and their impact on rental income, US expats are strongly advised to seek guidance from a tax professional. An expert in US tax law can help navigate these rules, ensure proper application based on your specific circumstances, and provide strategies to optimize your tax position.
What forms are needed for reporting rental income?
The key forms and documentation required include:
- Schedule E (Form 1040): This form is used to report rental income and expenses. It details the income received from the property, along with allowable expenses such as mortgage interest, property taxes, maintenance costs, and depreciation.
- Form 4562: If you claim depreciation on the property, this form is used to report the depreciation and amortization.
- Records and Receipts: Keeping meticulous records of all rental income and expenses is essential. This includes bank statements, receipts, invoices, and any other relevant financial documentation.
- Additional Forms for Foreign Properties: If your rental property is located outside the US, additional reporting may be required depending on your situation.
Should I get a tax professional’s advice?
Engaging a tax professional is highly advisable, especially for US expats with rental properties. Here’s why:
- Maximizing Deductions: They can assist in identifying all allowable deductions to minimize your tax liability.
- Avoiding Penalties: Accurate filing is crucial to avoid penalties. A tax professional can ensure that all necessary forms are correctly completed and submitted on time.
- Understanding Complex Tax Laws: US tax laws, especially those related to rental income and property, can be complex and frequently change. A tax professional stays updated on these changes and can provide guidance on how they affect your rental property.
- Strategic Tax Planning: Beyond annual tax filing, a tax professional can offer strategic advice on long-term tax planning. This includes structuring your rental activities for optimal tax efficiency and planning for future events such as property sales or expansions of your rental portfolio.
While managing rental income taxation requires diligence and understanding of IRS regulations, seeking the advice of a tax professional can provide peace of mind and financial benefits. They can offer tailored advice and strategies for effective tax planning, ensuring that you remain compliant while optimizing your tax situation.
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