Each year, the IRS requires individuals to report and pay taxes on income they earned. But the form you use to report that income may differ depending on how and where you earned it. Certain types of income — considered supplemental income by the IRS — are filed on Form 1040 Schedule E. In this article, you’ll learn what the Schedule E form is and when you might need to file it as part of your annual tax return.
What is Tax Form 1040 Schedule E and How is It Related to Investing?
The Form 1040 Schedule E is a tax form the IRS requires individuals to file with their annual tax return if they received any supplemental income throughout the year. For the purposes of the Schedule E form, supplemental income includes income and losses from rental real estate, royalties, partnerships, S-corporations, estates, trusts and REMICs.
Many investors are required to file a Schedule E form depending on the type of assets they invest in. In cases where you invest in real estate or certain mortgage-backed securities, you may have to file a Schedule E. The same may apply if you’re a passive partner (aka “silent investor”) in a partnership or S-corporation.
Further Reading: How to Minimize Your Tax Bill?
Schedule E for Rental Income
One of the most common uses of the Schedule E form is to report rental income earned from real estate holdings, which could include single-family residences, multi-family residences, vacation, and short-term rentals, commercial properties, and land.
If you own an investment property that you rent out to a tenant, you must report that income on your Schedule E form. The good news is that as long as you didn’t use the property as your home, you can also report and deduct your expenses.
Expenses you can deduct include:
- Auto and travel
- Cleaning and maintenance
- Legal and other professional fees
- Management fees
- Mortgage interest
- Other interest
- Depreciation or depletion
Other Types of Schedule E Income
Real estate rental income is one of the most common situations where someone might have to file a Schedule E form, but it’s not the only one. Here are a few other situations where a Schedule E might be required.
Royalty income is money someone earns by allowing someone else to use their property. Royalty income can result from intellectual property such as copyrights and patents. Someone could also earn royalty income from oil, gas and minerals extracted from their property. Royalty income is reported in Part I of the Schedule E form.
Partnerships and S-Corporations
Partnerships and S-corporations are both pass-through entities, meaning the company itself doesn’t claim any income, losses, or deductions. Instead, they pass through to the partners. Members of partnerships and S-corporations receive a Schedule K-1 for their income, losses, and deductions each year, which they file in Part II of the Schedule E form.
Estates and Trusts
Beneficiaries of estates and trusts must report their share of the income in Part III of the Schedule E form. This type of income is often interest earned on the assets within the estate or trust. Beneficiaries will receive a Schedule K-1 that includes all income and losses to report.
Residual Interests in REMICs
A real estate mortgage investment conduit (REMIC) is a type of mortgage-backed security that provides ongoing cash flow to investors. Individuals who hold interest in a REMIC must report their share of the taxable income and losses in Part IV of their Schedule E form.
The Passive Activity Loss Limit
Income that’s reported on the Schedule E form is considered supplemental income from a passive activity. The IRS defines passive activity as a business activity where you didn’t “materially participate.”
Because of the passive nature of this type of income, the IRS limits losses that you can deduct. For most types of Schedule E income, filers are limited to claiming the amount of loss they are at-risk for or could actually lose. For example, if you contributed $10,000 to the business in a given year, your losses for that year can’t be more than $10,000.
The rules work a bit differently for some real estate activities. You’re exempt from the IRS passive activity loss limit if you actively participated in real estate activities, if your net loss was $25,000 or less, and your modified adjusted gross income was $100,000 or less, among a few other rules.
Further Reading: How to Amend Your Taxes
If you earn supplemental income in any given year, the IRS requires that you fill out the Form 1040 Schedule E and file it with your annual tax return. Make sure you’re tracking your income and expenses throughout the year so you know your form is accurate. You might also consider hiring a tax professional, who can help you organize your paperwork and fill out the form.