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The IRS receives information from third parties, such as employers and financial institutions. Using an automated system, the Automated Underreporter (AUR) function compares the information reported by third parties to the information reported on your return to identify potential discrepancies.
You generally must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use or occupation of property. Expenses of renting property can be deducted from your gross rental income. You generally deduct your rental expenses in the year you pay them.
If you own a part interest in a rental real estate property, report only your part of the income and expenses on Schedule E. Complete lines 1a, 1b, and 2 for each rental real estate property. For royalty property, enter code 6 on line 1b and leave lines 1a and 2 blank for that property.
There are a few ways the IRS can find out if you have rental income. This could be from a routine tax audit or it could be because an error or abnormality in your tax filing has triggered an audit. Below we outline some of the key ways the IRS will know if you have rental income.
Partnerships and S corporations use Form 8825 to report income and deductible expenses from rental real estate activities, including net income (loss) from rental real estate activities that flow through from partnerships, estates, or trusts.
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Ways the IRS can find out about rental income include routing tax audits, real estate paperwork and public records, and information from a whistleblower.
Thus, you would have to report all of the rent you receive in income, but none of your expenses for the home would be deductible. (Actually, you would still be able to deduct the mortgage interest, assuming it otherwise qualifies as deductible, and property taxes. These items are deductible even for non-rental homes.)
Rental real estate proceeds are considered to be passive income, like stock profits. The tax code considers rental losses to be passive losses. In general, fewer taxpayers qualify for such deductions. By definition, they are not earned income.