If you earn rental income from U.S. real estate, the income and expenses are reported on a Schedule E. Depending on whether you are a U.S. citizen, resident, or non resident alien, the Schedule E is attached to a Form 1040, or 1040-NR.
Items reported on a Schedule E include:
- rental income received; and
- expenses related to the rental activity, such as repairs and maintenance fees, insurance, property taxes and depreciation.
Keep in mind that any personal use of the property will require you to prorate the expenses between the personal and the rental use. In addition, while costs incurred for routine repairs may be expensed, those that reflect capital improvements (such as renovations) must be capitalized.
Depreciation Expense
The charges incurred related to capital improvements are taken into income over time as follows:
- depreciation expense is generally claimed for the U.S. rental property;
- depreciation expense commences when the property begins to earn rental income and ends either when the property is no longer in use, or the expenditures have been fully recovered; and
- depreciation may only be claimed on the portion of the property used for rental purposes.
Non-Resident Aliens
Non-residents earning rental income from a U.S. property are generally subject to a 30% flat withholding rate on the gross rental income. Under this approach, expenses related to the property are not deducted.
It is possible, however, for a non-resident alien to elect to treat the rental income as effectively connected with a U.S. trade or business, thereby permitting the rental income to be taxed at graduated rates. Eligible rental expenses may then be deducted when filing a Form 1040-NR. In addition, the 30% withholding may be reduced, or even eliminated by filing the appropriate forms.
Rental Losses
After deducting eligible expenses for the rental property, it is possible to incur a rental loss. However, the amount that may be claimed may be restricted by the passive activity loss rules and only available for use against other passive activities, unless an exception applies. Note that no deduction is permitted for a rental loss, if the personal-use portion of the rental property is the greater of 14 days, or 10% of the rental use of the property.
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Karlene J. Mulraine, EA, CPA, CA, CPA (NH) is the President of Cross-Border Financial Professional Corporation. Follow us on Linkedin and Twitter, or hang out on Facebook.
The views expressed in this article are those of the author and should not be relied on to make decisions. Consider discussing your specific circumstances with an appropriate specialist.