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Income from Rents and Royalties

The law prevents most homeowners from deducting losses (expenses in excess of income) on the rental of a personal vacation home or personal residence if the owner or close relatives personally use the premises during the year. Tests based on days of personal and rental use determine whether you may deduct losses.

If you rent out an apartment or room in the same building in which you live, you report the rent income less expenses allocated to the rental property.

Rental losses may also be limited by the passive activity rules. Real estate professionals may avoid the passive restrictions on rental income. An investor who actively manages property may deduct rental losses of up to $25,000 under an exception to the passive activity loss restrictions.

  • Use Schedule E of Form 1040 to report real estate rental income and expenses. You must also file Form 4562 to claim depreciation deductions for buildings you acquired during the tax year.
  • Use Schedule C instead of Schedule E if you provide additional services for the convenience of the tenants, such as maid service. That is, Schedule C is used to report payments received for the use and occupancy of rooms or other areas in a hotel, motel, boarding house, apartment, tourist home, or trailer court where services are provided primarily for the occupant.
  • Business rentals of equipment, vehicles, or similar personal property are reported on Schedule C, not Schedule E.

Royalties are payment for use of copyrights or for the use and exhaustion of mineral properties. Royalties are taxable as ordinary income and are reported in Schedule E (Form 1040). But if you are a self-employed author, artist, or inventor, you report royalty income and expenses on Schedule C.

Royalty income includes:

  • License fees received for use, manufacture, or sale of a patented article
  • Renting fees received from patents, copyrights, and depletable assets (such as oil wells)
  • Author's royalties including advance royalties if not a loan
  • Royalties for musical compositions, works of art, etc.