Common Mistakes When Completing Schedule E

Tax Professionals Resource
May 14, 2012 — 1,678 views  
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According to the IRS, Schedule E Supplemental Income and Loss errors accounted for a loss to taxpayers of $13 billion in 2001. As a result, the agency has been working over the past decade to improve the reporting of income and loss related to passive activity. The IRS sends a letter to tax preparers when the agency finds that a 1040 Schedule E contains attributes indicating a high number of errors. In the letter, the IRS lists the three most common problems that preparers experience when reporting supplemental income and loss:

1. Rental income and expenses are not properly reported. Some common mistakes related to income reporting include recognizing rent when it is received. Even if the rent is being paid in advance for the subsequent tax year, the rent should still be recognized in the current year. Also, if a tenant pays expenses, that counts as income for the owner. Additionally, if landlords keep all or a portion of the deposit, then the deposit will count as income.

2. Rental depreciation is not correctly calculated. While a structure is depreciable, the land beneath the structure is not. Tax preparers often do not report the basis amount attributed to depreciable structure versus non-depreciable land. Also, if landlords pay for improvements that significantly add to the property’s value or to its useful life, then the expenses must be depreciated rather than deducted.

3. Limitation surrounding passive activities, basis and at-risk rules are not properly considered or calculated. If a property is both rented out and used by owners, then the tax treatment depends on how many days the owners use the property as a residence. This personal use threshold also includes rentals below market value and rentals to family members at market value. Also, expenses related to the property must be apportioned according to the number of days it was used for personal and rental use.

For landlords and tax preparers, keeping accurate records of all income and expenses related to a property is crucial to maintaining credibility with the IRS, especially for tax preparers who complete a high volume of returns. Since the IRS has specifically targeted Schedule E Supplemental Income and Loss reporting, landlords need to take great care to prepare their tax return correctly. Also, tax preparers must ask for documentation related to income and expenses and ensure that credits or deductions claimed are accurate.

Tax Professionals Resource