Preparing a Form 1040 Schedule E

Form 1040 Schedule E is used to report income or loss from rental proceeds, royalties, partnerships, S corporations, estates, trusts, and residual interests in real estate mortgage investment conduits (REMICs).

The following are common examples of income reported on a Schedule E:

  • Rental income collected from tenants in a residential or commercial building that the taxpayer owns.
  • The taxpayer's share of a partnership's income, losses, and deductions. These amounts are typically documented on a Schedule K-1 which the taxpayer receives from the partnership (read more here).
  • Income from a single-member domestic limited liability company (LLC), if the taxpayer is the sole member of the LLC.

At-Risk Rules and Passive Activity Loss Rules

The "at-risk rules" and the "passive activity loss rules" can limit the amount of losses that are deductible on Schedule E. The at-risk rules are applied first; losses that are still deductible after application of the at-risk rules are then subject to the passive activity loss rules.

The purpose of the at-risk rules is to limit the amount of loss to the amount that the taxpayer could actually lose in the activity that generated the loss. For instance, the taxpayer probably would not be at risk with respect to the following amounts and therefore would not be able to deduct losses from them:

  • Nonrecourse loans used to finance the activity, acquire property used in the activity, or acquire the taxpayer's interest in the activity (unless the loans are secured by the taxpayer's own property).
  • Cash, property, or borrowed amounts that are used in the activity and are protected against loss by a guarantee or stop-loss agreement.
  • Amounts borrowed for use in the activity from someone who has an interest in the activity.

Qualified nonrecourse financing is an amount at risk if it is secured by real property used in an activity of holding real property subject to the at-risk rules.

Losses from "passive activities" are usually deductible only to the extent of income from passive activities. Passive activities include most rental activities and any business activity in which the taxpayer did not "materially participate."

If the taxpayer is a real estate professional, then the taxpayer's rental real estate activities are not passive activities and the rental income is reported on Schedule C rather than on an E. The taxpayer is defined as a real estate professional if the following two criteria are met:

  • More than half of the services that the taxpayer performs are in real estate, AND
  • The taxpayer performs over 750 hours of service in real estate or owns a real estate businesses in which they materially participate.

To find out more about how a property loss may impact your taxes, see our article on Property Loss and Taxes.

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