Real estate investment is one of the most common ways to build wealth. And one of its main draws is that it is a passive activity, meaning that once you’ve made your investment (say, a rental property), the investment makes money for you— while you sleep, while you vacation, and even once you pass it on to loved ones— forever.
While the glitz and glam is in finding, buying and collecting income from investment properties (either through flips or through rental income), as many an entertainer and regular-Joe alike will tell you, troubles aplenty can flow from getting the tax-side wrong. Which leads me to the following: My Smart Cousin is NOT a certified public accountant (CPA), tax specialist or tax preparer, and NOTHING in this blog should be considered tax advice or accounting advice. That said, there are some high-level do’s and don’ts we can offer when it comes to the three most commons forms that you will encounter as a real estate investor: form 1099, Schedule E and Schedule C
WHAT IS FORM 1099?
A 1099 is not one IRS form but rather a collection of forms that report various kinds of payments. The three most common 1099s that you will encounter as a property investor are a 1099-C, a 1099-K and a 1099-NEC.
1099-C
If you are buying your first house for the price of a car, and are planning on renovating it and renting it out to someone who receives a housing choice voucher, then the Housing Authority will report the voucher payments, also called Section 8 payments, that were made to you on a 1099-C form. The Housing Authority will send a copy of the 1099-C to you as well as to the IRS, in the same way that your employer sends a W-2 wage both to you and to the IRS.
Your tenants will not report the rental payments that they make to you via a 1099-C or on any other tax form. But of course, that makes it no less real— you must self report this income, along with your 1099-C income, as rental income.
1099-K
To facilitate the above reporting, effective January 2022, Venmo, Zelle, CashApp and other electronic payment processors, will begin issuing a 1099-K to anyone who receives payments of $600 or more in a calendar year. Thus, if your rental payments are made by your tenants through one of these payment channels, you will need to maintain good records to pinpoint those payments listed on the 1099-K that are rent-related versus those that are not. Payments that your tenants made to you via money or or personal check will not be reported via a 1099-K, though certainly stay-tuned as rules may change in the future.
1099-NEC
As a real estate investor, you undoubtedly will make payments to a property manager, handyman, electrician, plumber, HVAC technician or other service professional that you hire to manage, renovate or repair your property. If these professionals are independent contractors, then you may want to issue them a 1099-NEC form, which will state the amount of money that you paid them, and help ensure that you are able to claim these expenses on your income taxes.
Likewise, if you provide property management, general contractor or other professional services to clients, perhaps as a component of your real estate investment business for instance, then you will be issued a 1099-NEC documenting the payments that were made to you.
The Schedule E
For real estate investors who are also landlords, the most common tax schedule that you will use is the Schedule E. Schedule E is the IRS’s form to report passive income, or income that is not derived from business operations. Schedule E income is generated from activities such as rental properties, royalties (say, from a song, movie or book) or interest in a trust.
The Schedule E reports financial information from your rental properties that is part balance sheet and part income statement. On it you will report the properties you own and how much you paid for them (balance sheet type items) and your rental income and maintenance expenses for the property (income statement type items).
If you own a property that wasn’t rented out at all (for instance, because it was vacant and in-between tenants, or because it was being renovated), you will still report it on your Schedule E. Likewise, if the property is a multifamily property but only one of the units was rented out during the calendar year, you will report rental income for the one unit.
Your accountant or tax preparer can walk you through the ins and outs of what expenses you can deduct and the deductibility limits, but generally, if you’re at least a 10% owner in the rental properties and you call the shots on any big decisions with the property, then you can deduct up to $25,000 of the losses from the rental income. Importantly, Schedule E losses (say, large maintenance expenses from prettying up a new property investment) generally cannot be deducted against 1040 income (say, income from your job or a Schedule C business).
Schedule C and Form 1120-S
If you establish an ancillary business to your real estate investment business— for instance, property management, lawn care, roof repair, general contractor or other venture— should you choose, you can form a company separate from your real estate investment company. If that separate company is a limited liability company (LLC), you will report the income and expenses for that company on a Schedule C return. If instead the company is formed as a sub chapter S firm, then you will report the income and expenses on form 1120-S.
THE BOTTOM LINE
Numerous tax forms can potentially apply to real estate investor. Hiring a CPA or tax professional should be job number one to help ensure that you properly report all items, avoid any missteps, and take advantage of opportunities and benefits that are available.
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