IRS Form 1040 Schedule E Analysis – Supplemental Income and Loss
- The IRS Form Schedule E is divided into five parts:
- Part I - Income or Loss From Rental Real Estate and Royalties
- Part II - Income or Loss From Partnerships and S Corporations
- Part III - Income or Loss From Estates and Trusts
- Part IV - Income or Loss From Real Estate Mortgage Investment Conduits (REMICs)
- Part V - Summary
IRS Form 1040 Schedule E http://www.irs.gov/uac/Schedule-E-(Form-1040),-Supplemental-Income-and-Loss
Note: Line 4 is for Royalty Income. This is income from business patents, copyrights, or royalty income from producing oil, gas or mioneral properties. Taxes reported on the 1099 are deducted from the gross amount, and the net amount from line 26 is reported on line 17 of the IRS Form 1040, and that amount is included in the cash flow on an individual or married applicants. The rest of this page covers investment property rental income, and partnerships and 1120S corporations, and estates and trusts.
Part I - Income or Loss From Rental Real Estate and Royalties is probably the most encountered, and easily understandable, of the five sections. It is primarily a straight-forward income statement for every individual investment real estate property owned by the applicant. It is utilized by both consumer and commercial credit analysts.
Part I, Section 1a, has three rows (A, B and C). This is where the address of the property is entered. All that is required is the the street address, city or town, state, and ZIP code. The number of rental properties should also equal the number of properties on the applicant's personal financial statement (PFS). If there are additional properties on the PFS then this could indicate that the applicant has purchased additional properties since filing the Schedule E. If a property on the Schedule E is not on the PFS, then this could indicate the property has been sold since filing the Schedule E.
Part I, Section 1b, has three rows (A, B and C), which is used to identify the type of property with a numerical code from the Type of Property list right below it. It will give you an idea of how many tenants may be at a specific property.
Part I, Section 2, has three rows (A, B and C). You have to look at the first column, Fair Rental Days, to determine how many days the specific property was rented during the tax year. You are looking for 365 to be entered in each row in the column. If it is less than 365 then you would have to determine what the rent is for an entire year in order to do an accurate cash flow of the property.
In Part I, Section 3 there are three columns per page, and each column is for a single, specific property. However, it is not uncommon for taxpayers to combine more than one property in a single column. Rows 3 is the gross, annual rent for each individual property in columns A, B and C. If more than one property is entered in either column A, B or C, then you will evenrually have to separate out each individual property's rent and expenses in order to do an accurate cash flow of the applicant's real estate portfolio.
Part I, Rows 5 through 19, intersect with the three column (A, B and C), and this is where the expenses incurred to own and operate each individual property in listed in columns A, B and C, are entered. These must be annual amounts as the rental income is also an annual amount.
Row 9, Insurance - this is one of the annual fixed costs of the property, insurance coverage is usually for 12 months.
Row 12, Mortgage interest paid to banks, etc. - if you see an amount entered in Row 12 then you know that there is a loan secured by the property. This is just the interest paid on an annual basis. You need to determine the actual monthly payment, which includes scheduled amortization, from the PFS or applicant in order to do a cash flow of the property.
Row 13, Other interest - if the interest was not paid to a financial institution, or the applicant did not receive a Form 1098 from the recipient, then the deductible loan interest is reported on line 13.
Row 16, Taxes - this means real estate taxes. Real estate taxes is the second annual fixed cost of the property, real estate taxes have to paid on an annual basis.
Row 18, Depreciation - is a capital expense. It is the mechanism for recovering your cost in an income producing property and must be taken over the expected life of the property. Depreciation is not an actual expense incurred on a monthly basis, there is no third-party sending an invoice. It is claimed on the Scedule E only at the time of filing the tax returns. Thus, it must either be ignored or added-back when computing the actual cash flow of the property.
If the applicant is a member of a partnership or joint venture, or a shareholder in an 1120S corporation, then Part II is used to report their taxable share of the partnership or 1120S corporation pass-through income (even if not received) or loss.