Cash or the fair market value of property or services you receive for the use of real estate or personal property is taxable to you as rental income. In general, you can deduct expenses of renting property from your rental income.
Rental Income
Most individuals operate on a cash basis, which means they count their rental income as income when it is actually or constructively received, and deduct their expenses when they are paid. Rental income includes:
Amounts paid to cancel a lease – If a tenant pays you to cancel a lease, this money is also rental income and is reported in the year you receive it.
Advance rent – Generally, you include any advance rent paid in income in the year you receive it regardless of the period covered or the method of accounting you use.
Expenses paid by a tenant – If your tenant pays any of your expenses, those payments are rental income. You may also deduct the expenses if they are considered deductible expenses.
Security deposits – Do not include a security deposit in your income if you may be required to return it to the tenant at the end of the lease. If you keep part or all of the security deposit because the tenant breaks the lease by vacating the property early, include the amount you keep in your income in that year. If you keep part or all of the security deposit because the tenant damaged the property and you must make repairs, include the amount you keep in that year if your practice is to deduct the cost of repairs as expenses. To the extent the security deposit reimburses those expenses, do not include the amount in income if your practice is not to deduct the cost of repairs as expenses. If a security deposit amount is to be used as the tenant’s final month’s rent, it is advance rent that you include as income when you receive it, rather than when you apply it to the last month’s rent.
Rental Expenses
Examples of expenses that you may deduct from your total rental income include:
Depreciation – Allowances for exhaustion, wear and tear (including obsolescence) of property. You begin to depreciate your rental property when you place it in service. You can recover some or all of your original acquisition cost and the cost of improvements beginning in the year your rental property is first placed in service, and beginning in any year you make improvements or add furnishings.
Repair Costs – Expenditures made to keep your property in good working condition but do not add to the value of the property.
Operating Expenses – Other expenditures necessary for the operation of the rental property, such as the salaries of employees or fees charged by independent contractors (groundkeepers, bookkeepers, accountants, attorneys, etc.) for services provided.
If you are a cash basis taxpayer, you cannot deduct uncollected rents as an expense because you have not included those rents in income. Repair costs, such as materials, are usually deductible.
Personal Use
There are special rules relating to the rental of real property that you also use as your main home or your vacation home. For information on income from these rentals, or from renting at an amount less than the fair market value, refer to Taxes When Renting Residential and Vacation Property.
Limitations
If you do not use the rental property as a home and you are renting to make a profit, your deductible rental expenses can be more than your gross rental income, subject to certain limits. For information on these limitations, refer to Income Losses and Credits from Passive Activities Explained.
Net Investment Income Tax
If you have a rental profit, you may be subject to the Net Investment Income Tax (NIIT). For more information, refer to What is Net Investment Income Tax (NIIT).
Almost everything you own and use for personal or investment purposes is a capital asset. Examples include a home, personal-use items like household furnishings, and stocks or bonds held as investments. When you sell a capital asset, the difference between the adjusted basis in the asset and the amount you realized from the sale is a capital gain or a capital loss. You have a capital gain if you sell the asset for more than your adjusted basis. You have a capital loss if you sell the asset for less than your adjusted basis. Losses from the sale of personal-use property, such as your home or car, are not tax deductible.
Capital gains and losses are classified as long-term or short-term. If you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term. To determine how long you held the asset, count from the day after the day you acquired the asset up to and including the day you disposed of the asset.
If you have a net capital gain, a lower tax rate may apply to the gain than the tax rate that applies to your ordinary income. The term “net capital gain” means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss for the year. The term “net long-term capital gain” means long-term capital gains reduced by long-term capital losses including any unused long-term capital loss carried over from previous years. The tax rate on most net capital gain is no higher than 15% for most taxpayers. Some or all net capital gain may be taxed at 0% if you are in the 10% or 15% ordinary income tax brackets. However, a 20% tax rate on net capital gain applies to the extent that a taxpayer’s taxable income exceeds the thresholds set for the 39.6% ordinary tax rate ($413,200 for single; $464,850 for married filing jointly or qualifying widow(er); $439,000 for head of household, and $232,425 for married filing separately).
There are a few other exceptions where capital gains may be taxed at rates greater than 15%:
The taxable part of a gain from selling section 1202 qualified small business stock is taxed at a maximum 28% rate.
Net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28% rate.
The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate.
Note: Net short-term capital gains are subject to taxation as ordinary income at graduated tax rates.
Taxpayers with significant investment income may be subject to the Net Investment Income Tax (NIIT). For additional information on the NIIT, see What is Net Investment Income Tax (NIIT).
An Individual Taxpayer Identification Number (ITIN) is a tax processing number issued by the Internal Revenue Service. It is a nine-digit number that always begins with the number 9 and has a range of 70-88 in the fourth and fifth digit. Effective April 12, 2011, the range was extended to include 900-70-0000 through 999-88-9999, 900-90-0000 through 999-92-9999 and 900-94-0000 through 999-99-9999. IRS issues ITINs to individuals who are required to have a U.S. taxpayer identification number but who do not have, and are not eligible to obtain a Social Security Number (SSN) from the Social Security Administration (SSA).
ITINs are issued regardless of immigration status because both resident and nonresident aliens may have a U.S. filing or reporting requirement under the Internal Revenue Code.
Individuals must have a filing requirement and file a valid federal income tax return to receive an ITIN, unless they meet an exception.
What is an ITIN used for?
ITINs are for federal tax reporting only, and are not intended to serve any other purpose. IRS issues ITINs to help individuals comply with the U.S. tax laws, and to provide a means to efficiently process and account for tax returns and payments for those not eligible for Social Security Numbers (SSNs).
An ITIN does not authorize work in the U.S. or provide eligibility for Social Security benefits or the Earned Income Tax Credit.
Who needs an ITIN?
IRS issues ITINs to foreign nationals and others who have federal tax reporting or filing requirements and do not qualify for SSNs. A non-resident alien individual not eligible for a SSN who is required to file a U.S. tax return only to claim a refund of tax under the provisions of a U.S. tax treaty needs an ITIN.
Other examples of individuals who need ITINs include:
A nonresident alien required to file a U.S. tax return
A U.S. resident alien (based on days present in the United States) filing a U.S. tax return
A dependent or spouse of a U.S. citizen/resident alien
A dependent or spouse of a nonresident alien visa holder
How do I know if I need an ITIN?
If you do not have a SSN and are not eligible to obtain a SSN, but you have a requirement to furnish a federal tax identification number or file a federal income tax return, you must apply for an ITIN.
If you have an application for a SSN pending, do not file Form W-7. Complete Form W-7 only if the Social Security Administration (SSA) notifies you that a SSN cannot be issued.
To obtain a SSN, see Form SS-5, Application for a Social Security Card. To get Form SS-5 or to find out if you are eligible to obtain a SSN, go to Social Security Administration or contact a SSA office. By law, an alien individual cannot have both an ITIN and a SSN.
IRS processes returns showing SSNs or ITINs in the blanks where tax forms request SSNs. IRS no longer accepts, and will not process, forms showing “SSA”, 205c”, “applied for”, “NRA”,& blanks, etc.
How do I apply for an ITIN?
Use the latest revision of Form W-7, Application for IRS Individual Taxpayer Identification Number to apply. Attach a valid federal income tax return, unless you qualify for an exception, and include your original proof of identity or copies certified by issuing agency and foreign status documents.
Because you are filing your tax return as an attachment to your ITIN application, you should not mail your return to the address listed in the Form 1040, 1040A or 1040EZ instructions. Instead, send your return, Form W-7 and proof of identity and foreign status documents to:
Internal Revenue Service
Austin Service Center
ITIN Operation
P.O. Box 149342
Austin, TX 78714-9342
You may also apply using the services of an IRS-authorized Acceptance Agent or visit some key IRS Taxpayer Assistance Center in lieu of mailing your information to the IRS in Austin. Taxpayer Assistance Centers (TACs) in the United States provide in-person help with ITIN applications on a walk-in or appointment basis. The IRS’s ITIN Unit in Austin issues all numbers through the mail.
When should I apply for an ITIN?
You should complete Form W-7 as soon as you are ready to file your federal income tax return, since you need to attach the return to your application.
If you meet one of the exceptions to the tax filing requirement, submit Form W-7, along with the documents that prove your identity and foreign status. You are also required to include supplemental documents to substantiate your qualification for the exception, as soon as possible after you determine that you are covered by that exception.
You can apply for an ITIN any time during the year. However, if the tax return you attach to Form W-7 is filed after the return’s due date, you may owe interest and/or penalties. You should file your current year return by the prescribed due date to avoid this situation.
Where can I get help with my ITIN application?
You can call the IRS toll-free at 1-800-829-1040 if you are in the United States. If you are outside the United States, call 267-941-1000 (not a toll-free number) for information and help in completing your Form W-7 and your tax return or to check on the status of your application six weeks after submitting Form W-7.
Assistance is also available at selected IRS Taxpayer Assistance Centers in the United States to provide in-person help with ITIN applications on a walk-in or appointment basis.You may also use the services of an IRS-authorized Acceptance Agent.
How and when can I expect to receive my ITIN?
If you qualify for an ITIN and your application is complete, you will receive a letter from the IRS assigning your tax identification number usually within seven weeks. If you have not received your ITIN or other correspondence seven weeks after applying, call the IRS toll-free number at 1-800-829-1040 to request the status of your application if you are in the United States. If you are outside the United States, call 267-941-1000 (not a toll-free number).
Withholding of Tax on Dispositions of United States Real Property Interests
The disposition of a U.S. real property interest by a foreign person (the transferor) is subject to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding. FIRPTA authorized the United States to tax foreign persons on dispositions of U.S. real property interests.
A disposition means “disposition” for any purpose of the Internal Revenue Code. This includes but is not limited to a sale or exchange, liquidation, redemption, gift, transfers, etc. Persons purchasing U.S. real property interests (transferees) from foreign persons, certain purchasers’ agents, and settlement officers are required to withhold 15% (10% for dispositions before February 17, 2016) of the amount realized on the disposition (special rules for foreign corporations).
In most cases, the transferee/buyer is the withholding agent. If you are the transferee/buyer you must find out if the transferor is a foreign person. If the transferor is a foreign person and you fail to withhold, you may be held liable for the tax. For cases in which a U.S. business entity such as a corporation or partnership disposes of a U.S. real property interest, the business entity itself is the withholding agent.
U.S. Real Property Interest
A U.S. real property interest is an interest, other than as a creditor, in real property (including an interest in a mine, well, or other natural deposit) located in the United States or the U.S. Virgin Islands, as well as certain personal property that is associated with the use of real property (such as farming machinery). It also means any interest, other than as a creditor, in any domestic corporation unless it is established that the corporation was at no time a U.S. real property holding corporation during the shorter of the period during which the interest was held, or the 5-year period ending on the date of disposition (applicable periods).
An interest in a corporation is not a U.S. real property interest if:
Such corporation did not hold any U.S. real property interests on the date of disposition,
All the U. S. real property interests held by such corporation at any time during the shorter of the applicable periods were disposed of in transactions in which the full amount of any gain was recognized, and
For dispositions after December 17, 2015, such corporation and any predecessor of such corporation was not a RIC or a REIT during the shorter of the applicable periods during which the interest was held.
Rates of Withholding
The transferee must deduct and withhold a tax on the total amount realized by the foreign person on the disposition. The rate of withholding generally is 15% (10% for dispositions before February 17, 2016).
The amount realized is the sum of:
The cash paid, or to be paid (principal only);
The fair market value of other property transferred, or to be transferred; and
The amount of any liability assumed by the transferee or to which the property is subject immediately before and after the transfer.
If the property transferred was owned jointly by U.S. and foreign persons, the amount realized is allocated between the transferors based on the capital contribution of each transferor.
A foreign corporation that distributes a U.S. real property interest must withhold a tax equal to 35% of the gain it recognizes on the distribution to its shareholders.
A domestic corporation must withhold tax on the fair market value of the property distributed to a foreign shareholder if:
The shareholder’s interest in the corporation is a U.S. real property interest, and
The property distributed is either in redemption of stock or in liquidation of the corporation.
For distributions before February 17, 2016, the corporation generally must withhold 10% of the amount realized by a foreign person. For distributions after February 16, 2016, the rate increases to 15%.
A 3.8 percent Net Investment Income Tax (NIIT) applies to individuals, estates, and trusts that have net investment income above applicable threshold amounts.
Individuals
In the case of an individual, the NIIT is 3.8 percent on the lesser of:
the net investment income, or
the excess of modified adjusted gross income over the following threshold amounts:
$250,000 for married filing jointly or qualifying widow(er) with dependent child
$125,000 for married filing separately
$200,000 in all other cases
Estates & Trusts
In the case of an estate or trust, the NIIT is 3.8 percent on the lesser of:
(A) the undistributed net investment income, or
(B) the excess (if any) of:
the adjusted gross income over the dollar amount at which the highest tax bracket begins for an estate or trust for the tax year. (For estates and trusts, the 2015 threshold is $12,300)
Definition of Net Investment Income and Modified Adjusted Gross Income
In general, net investment income for purpose of this tax, includes, but is not limited to:
interest, dividends, certain annuities, royalties, and rents (unless derived in a trade or business in which the NIIT does not apply),
income derived in a trade or business which is a passive activity or trading in financial instruments or commodities, and
net gains from the disposition of property (to the extent taken into account in computing taxable income), other than property held in a trade or business to which NIIT does not apply.
The NIIT does not apply to certain types of income that taxpayers can exclude for regular income tax purposes such as tax-exempt state or municipal bond interest, Veterans Administration benefits, or gain from the sale of a principal residence on that portion that is excluded for income tax purposes.
Modified adjusted gross income (MAGI), for purposes of the NIIT, is generally defined as adjusted gross income (AGI) for regular income tax purposes increased by the foreign earned income exclusion (but also adjusted for certain deductions related to the foreign earned income). For individual taxpayers who have not excluded any foreign earned income, their MAGI is generally the same as their regular AGI.
