Auditing Schedule E Income and Expense Categories
Tax forms can be intimidating, and the Schedule E is no exception. It’s helpful to review your tax forms and instructions before it’s time to file. That’s why we’re examining the Schedule E’s income and expense categories that are specific to real estate investors. When it’s time for you to complete your Schedule E, you’ll be confident that your reportable income is accurate and your deductible expenses are properly categorized.
Let’s start with a little background information.
What’s the Schedule E for?
The IRS Schedule E form goes along with your 1040 return to report supplemental income and losses. This income is from passive activities, like rental property. Income earned from an active business activity, like a W-2 job, goes on your 1040.
Do you offer tenants substantial services, such as meals or guided tours? Do you participate materially in a real estate investment business? If so, you may need to file a Schedule C along with your 1040 instead of the Schedule E. The Schedule C is more for active business activities, like a company focused on flipping houses or property development.
For an overview focused on the Schedule E’s Part I as a whole, see our article “Understanding the Schedule E for Rental Properties.” In this discussion, we’re looking only at Lines 3 through 19, the income and expense categories.
Schedule E Rents Received
Line 3 of the Schedule E is for rents received. This section may seem straightforward, but it trips up many people—in fact, it’s one of the top five errors we see in rental property bookkeeping. Rents received include more than just monthly rents. When you total up your reportable rental income for the year, include these payments:
• Advance rent payments
• Expenses paid by the tenant instead of rent
• Income from late fees
• Income from renting rooms, buildings, or other spaces
• Lease cancellation fees
• Prorated rents
• Security deposits withheld
• Services or property received instead of rent
• Utility reimbursements
If your tenant provided services or property instead of rent, use the fair market value of the property or services as your reportable income.
Note that if you expect to return a tenant’s security deposit once the lease ends, you won’t include the deposit in your income this year.
The IRS may penalize taxpayers who underreport their income, so fill out this part of the Schedule E carefully to avoid accuracy-related penalties and interest.
Schedule E Expense Categories
Before we tackle the individual expense lines, let’s review the general guidelines the IRS provides about deductible expenses:
• Deduct all ordinary and necessary expenses that fall into the categories listed below.
• Do not include the value of your labor in any categories.
• Do not include amounts paid for fixed assets or improvements.
• If you’re a house hacker, deduct only the portion of your expenses that apply to the rented parts of your home.
Remember, if you’re not sure whether an expenditure is deductible, flag it and ask your CPA or financial adviser about it.
Line 5: Advertising
For this category, include any costs associated with marketing your rental properties. Think about website expenses, social media ads, online listings, newspaper ads, yard signs, mailers, business cards, or fees for hiring a marketing firm or consultant.
Line 6: Auto and Travel
Deductible travel for rental property owners means costs associated with traveling from home for rental activities, like routine inspections, showing properties, property repairs, etc.
Travel costs incurred to purchase your first rental property are not deductible. When you travel to a new city or state to expand your rental property business, those costs aren’t immediately deductible either. Refer to our resource article for a full review of accounting for business-related travel costs.
Actual Auto Expenses
Your actual auto expenses include the cost of fuel, insurance, repairs, parking fees, tolls, etc. that are related to your rental activities.
The Standard Mileage Deduction
If you take the standard mileage deduction, keep a mileage log and record the purpose of your trip and any relevant details.
Also, if you lease a vehicle, check how you handled your auto deductions previously. If you used the standard mileage deduction in prior years, the IRS requires you to keep using the standard mileage deduction. You may not switch to deducting your actual auto costs.
Calculate the standard mileage deduction with three steps:
• Determine the number of miles driven related to your rental property activities.
• Multiply the number of miles driven for 2023 by 65.5 cents per mile.
• Then add the cost of any parking fees and tolls.
Leave out any rental or lease payments, depreciation, or actual auto costs.
For more information on the mileage deduction, review our related article.
Line 7: Cleaning and Maintenance
Many popular accounting software choices group repairs and maintenance costs. However, use this category to deduct only maintenance-related expenses. Repairs go on Line 14.
Your cleaning and maintenance deductions include both the cost of labor, supplies, and small equipment for lawn care, pest control, snow removal, pressure washing, cleaning to prep the unit, etc.
Line 8: Commissions
Did you pay a referral fee to someone for finding you a tenant? If so, record those commission payments here. Do not include commissions related to the purchase of new properties.
Line 9: Insurance
Your premium payments for homeowner, flood, or hazard insurance and any additional policies will go on Line 9.
However, be careful if your insurance is part of your escrow payments. Deduct your insurance premiums only when the lender pays the insurance company. The funds are technically still in your possession as long as they’re in your escrow account. Until the funds move out of the account, they aren’t deductible.
Line 10: Legal and Other Professional Fees
If you paid a lawyer to create new lease documents or review contracts, record those costs here. Fees for tax advice, form preparation, or filing go on Line 10 as well.
Note that some legal fees are added to the property’s basis:
• Costs to protect your property’s title
• Fees paid to recover property
• Outlays to develop property
These may not be deducted in the year the fees were paid.
When you have software costs, like an REI Hub subscription or property management software fees, record those here too.
Line 11: Management Fees
Fees for a property manager or management company go on Line 11. Short-term rental platforms like Airbnb and Vrbo often have guest-service or host-service fees. Include those costs here.
Line 12: Mortgage Interest
The interest related to your rental property mortgage is deductible. The principal of the payment is not. That’s why recording your mortgage payments properly is important.
When you pay $600 or more in interest, your lending institution should send you Form 1098, showing your total interest paid for the year. Even if you don’t receive a 1098 form, still report your deductible mortgage interest on Line 12.
If you paid for points or loan origination fees, those costs are part of the property’s basis. They’re not deductible immediately.
Line 13: Other Interest
Use Line 13 to record credit card interest charges that are related to your rental business. You may also deduct interest paid to nonbank lenders like these:
• Crowdfunding platforms
• Private businesses
• Private investors
• Relatives
Be careful with prepaid interest payments—only deduct prepaid interest in the year it’s allocated for.
Line 14: Repairs
In this line, only include the costs related to keeping the property in operating condition. Repairs correct issues and keep the property functional. So, expenses associated with repairing leaky faucets, fixing broken steps, or repainting a room would go here.
Capital improvements aren’t immediately deductible. For a full discussion on repairs vs. capital improvements, refer to this resource.
Line 15: Supplies
You may deduct office equipment or supplies purchased for managing your rental property. Think about calendars, notepads, printing costs, small tools, etc.
Line 16: Taxes
The taxes related to your investment property go on Line 16. You may also include fees associated with renting the property:
• Property taxes
• Occupancy taxes
• School district taxes
• Local licensing fees
• Special easement assessments
Do not deduct your income taxes here.
Line 17: Utilities
Do you pay for any of the utilities at your rental property? If so, those costs are deductible. If your tenant reimburses you for those costs, remember to record the reimbursements as income.
When the tenant pays for the utilities directly, those costs are not deductible.
If you have a cell phone or phone line used only for your rental business, include those expenses in this section. However, if your phone is for both business and personal use, you may deduct only the cost of the calls related to your business. The base rate of your phone plan, including taxes and other charges, isn’t deductible.
Line 18: Depreciation Expense or Depletion
Depreciation helps you recover the cost of fixed assets and improvements. So even though you can’t write off a new HVAC system the year it’s installed, you can reclaim part of the expenditure each year.
REI Hub’s Fixed Asset Schedule provides both the accumulated depreciation and recommended depreciation for each of your recorded fixed assets. Some assets qualify for bonus or accelerated depreciation, though, so check with your tax adviser before completing Line 18.
Line 19: Other (List)
This is where you list expenses that don’t fit nicely in the previous lines. It’s a broad category, but all the costs you include here must relate to your rental property’s ownership, maintenance, or management. It’s highly likely that you have at least a few expenses that fit here:
• Bank fees
• Education costs
• Professional development dues
• HOA fees
• Gifts for clients or tenants
If you aren’t absolutely certain whether an outlay belongs in this section, ask your tax adviser.
Takeaways
Reviewing your tax forms and instructions before it’s time to file helps you tackle your tax prep more efficiently. When you understand what the IRS is asking for and where to report the information, you can file accurate returns. REI Hub’s audit of Schedule E income and expense categories provides a solid foundation. But you can go even further with our accounting software that’s designed for you and your rental property business. REI Hub has a built-in Schedule E report you can generate for each of your properties come tax time. Sign up for a free trial today so you can approach this tax season with confidence.
