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Free income tax service Publication 3402 - Main Content Table of Contents What is a Limited Liability Company? Classification of an LLC LLCs Classified as Partnerships LLCs Classified as Disregarded Entities LLCs Classified as Corporations Subsequent Elections How To Get More InformationInternal Revenue Service Small Business Administration Other Federal Agencies What is a Limited Liability Company? For purposes of this publication, a limited liability company (LLC) is a business entity organized in the United States under state law. Free income tax service Unlike a partnership, all of the members of an LLC have limited personal liability for its debts. Free income tax service An LLC may be classified for federal income tax purposes as a partnership, corporation, or an entity disregarded as separate from its owner by applying the rules in Regulations section 301. Free income tax service 7701-3. Free income tax service The information in this publication applies to LLCs in general, and different rules may apply to special situations, including banks, insurance companies, or nonprofit organizations that are LLCs or that own LLCs. Free income tax service Check your state's requirements and the federal tax regulations for further information. Free income tax service Classification of an LLC Default classification rules. Free income tax service   An LLC with at least two members is classified as a partnership for federal income tax purposes. Free income tax service An LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes). Free income tax service Also, an LLC's federal tax classification can subsequently change under certain default rules discussed later. Free income tax service Elected classification. Free income tax service   If an LLC does not choose to be classified under the above default classifications, it can elect to be classified as an association taxable as a corporation or as an S corporation. Free income tax service After an LLC has determined its federal tax classification, it can later elect to change that classification. Free income tax service For details, see Subsequent Elections, later. Free income tax service LLCs Classified as Partnerships If an LLC has at least two members and is classified as a partnership, it generally must file Form 1065, U. Free income tax service S. Free income tax service Return of Partnership Income. Free income tax service Generally, an LLC classified as a partnership is subject to the same filing and reporting requirements as partnerships. Free income tax service For certain purposes, members of an LLC are treated as limited partners in a limited partnership. Free income tax service For example, LLC members are treated as limited partners for purposes of material participation under the passive activity limitation rules (see Temporary Regulation section 1. Free income tax service 469-5T(e)). Free income tax service See the Instructions for Form 1065 for reporting rules that apply specifically to LLCs. Free income tax service Member manager. Free income tax service   Only a member manager of an LLC can sign the partnership tax return. Free income tax service And only a member manager can represent the LLC as the tax matters partner under the consolidated audit proceedings in sections 6221 through 6234. Free income tax service A member manager is any owner of an interest in the LLC who, alone or together with others, has the continuing authority to make the management decisions necessary to conduct the business for which the LLC was formed. Free income tax service If there are no elected or designated member managers, each owner is treated as a member manager. Free income tax service Change in default classification. Free income tax service   If the number of members in an LLC classified as a partnership is reduced to only one member, it becomes an entity disregarded as separate from its owner under Regulations section 301. Free income tax service 7701-3(f)(2). Free income tax service However, if the LLC has made an election to be classified as a corporation (discussed later) and that elective classification is in effect at the time of the change in membership, the default classification as a disregarded entity will not apply. Free income tax service   Other tax consequences of a change in membership, such as recognition of gain or loss, are determined by the transactions through which an interest in the LLC is acquired or disposed of. Free income tax service If a partnership that becomes a disregarded entity as a result of a decrease in the number of members makes an election to be classified as a corporation, the applicable deemed transactions discussed under Subsequent Elections, later, apply. Free income tax service Example 1. Free income tax service Ethel and Francis are members of an LLC classified as a partnership for federal tax purposes. Free income tax service Each holds an equal membership interest. Free income tax service The LLC does not hold any unrealized receivables or substantially appreciated inventory. Free income tax service Ethel sells her entire interest in the LLC to Francis for $10,000. Free income tax service After the sale, the business is continued by the LLC, which is owned solely by Francis. Free income tax service No entity classification election is made after the sale to treat the LLC as a corporation for federal tax purposes. Free income tax service The partnership terminates when Francis buys Ethel's entire interest. Free income tax service Ethel must treat the transaction as the sale of a partnership interest and must report gain or loss, if any, resulting from the sale of her partnership interest. Free income tax service For purposes of determining the tax treatment of Francis, the partnership is deemed to make a liquidating distribution of all of its assets to Ethel and Francis, and after this distribution, Francis is treated as acquiring the assets deemed to have been distributed to Ethel in liquidation of Ethel's partnership interest. Free income tax service Francis's basis in the assets attributable to Ethel's one-half interest in the partnership is $10,000, the purchase price for Ethel's partnership interest. Free income tax service Upon the termination of the partnership, Francis is considered to receive a distribution of those assets attributable to Francis's former interest in the partnership. Free income tax service Francis must recognize gain or loss, if any, on the deemed distribution of the assets to the extent required by Internal Revenue Code section 731(a). Free income tax service See Partnership Distributions in Publication 541. Free income tax service Example 2. Free income tax service George and Henrietta are members of an LLC classified as a partnership for federal tax purposes. Free income tax service Each holds an equal membership interest. Free income tax service The LLC does not hold any unrealized receivables or substantially appreciated inventory. Free income tax service George and Henrietta each sell their entire interests in the LLC to Ian, an unrelated person, in exchange for $10,000. Free income tax service After the sale, the business is continued by the LLC, which is owned solely by Ian. Free income tax service No entity classification election is made after the sale to treat the LLC as a corporation for federal tax purposes. Free income tax service The partnership terminates when Ian purchases the entire interests of George and Henrietta in the LLC. Free income tax service George and Henrietta must report gain or loss, if any, resulting from the sale of their partnership interests. Free income tax service For purposes of classifying the acquisition by Ian, the partnership is deemed to make a liquidating distribution of its assets to George and Henrietta. Free income tax service Immediately following this distribution, Ian is deemed to acquire, by purchase, all of the former partnership's assets. Free income tax service   For more details on the preceding two examples, see Revenue Ruling 99-6, 1999-6 I. Free income tax service R. Free income tax service B. Free income tax service 6. Free income tax service You can find Revenue Ruling 99-6 at www. Free income tax service irs. Free income tax service gov/pub/irs-irbs/irb99-06. Free income tax service pdf. Free income tax service LLCs Classified as Disregarded Entities If an LLC has only one member and is classified as an entity disregarded as separate from its owner, its income, deductions, gains, losses, and credits are reported on the owner's income tax return. Free income tax service For example, if the owner of the LLC is an individual, the LLC's income and expenses would be reported on the following schedules filed with the owner's Form 1040: Schedule C, Profit or Loss from Business (Sole Proprietorship); Schedule C-EZ, Net Profit From Business (Sole Proprietorship); Schedule E, Supplemental Income and Loss; or Schedule F, Profit or Loss From Farming. Free income tax service Employment tax and certain excise taxes. Free income tax service   A single-member LLC that is classified as a disregarded entity for income tax purposes is treated as a separate entity for purposes of employment tax and certain excise taxes. Free income tax service For wages paid after January 1, 2009, the single-member LLC is required to use its name and employer identification number (EIN) for reporting and payment of employment taxes. Free income tax service A single-member LLC is also required to use its name and EIN to register for excise tax activities on Form 637; pay and report excise taxes reported on Forms 720, 730, 2290, and 11-C; and claim any refunds, credits, and payments on Form 8849. Free income tax service See the employment and excise tax returns for more information. Free income tax service Self-employment tax rule for disregarded entity LLCs. Free income tax service   An individual owner of a single-member LLC classified as a disregarded entity is not an employee of the LLC. Free income tax service Instead, the owner is subject to tax on the net earnings from self-employment of the LLC which is treated in the same manner as a sole-proprietorship. Free income tax service Example 3. Free income tax service LLC is a disregarded entity owned by Irene. Free income tax service LLC has three employees (Kent, Patricia, and Tex) and pays wages. Free income tax service LLC is treated as an entity separate from its owner for purposes of employment taxes. Free income tax service For the wages paid to Kent, Patricia, and Tex, LLC is liable for income tax withholding, Federal Insurance Contributions Act (FICA) taxes, and Federal Unemployment Tax Act (FUTA) taxes. Free income tax service In addition, LLC must file under its name and EIN the applicable employment tax returns; make timely employment tax deposits; and file with the Social Security Administration and furnish to LLC's employees (Kent, Patricia, and Tex) Forms W-2, Wage and Tax Statement. Free income tax service Irene is self-employed for purposes of the self-employment tax. Free income tax service Thus, Irene is subject to self-employment tax on her net earnings from self-employment with respect to LLC's activities. Free income tax service Irene is not an employee of LLC for purposes of employment taxes. Free income tax service Because LLC is treated as a sole proprietorship of Irene for income tax purposes, Irene must report the income and expenses from LLC on her Schedule C. Free income tax service Irene will figure the tax due on her net earnings from self-employment on Schedule SE. Free income tax service Irene can also deduct one-half of her self-employment tax on line 27 of her Form 1040. Free income tax service Taxpayer identification number. Free income tax service   For all income tax purposes, a single-member LLC classified as a disregarded entity must use the owner's social security number (SSN) or EIN. Free income tax service This includes all information returns and reporting related to income tax. Free income tax service For example, if a disregarded entity LLC that is owned by an individual is required to provide a Form W-9, Request for Taxpayer Identification Number and Certification, the LLC must provide the owner's SSN or EIN, not the LLC's EIN. Free income tax service   However, most new single-member LLCs classified as a disregarded entity will need to obtain an EIN for the LLC. Free income tax service An LLC will need an EIN if it has any employees or if it will be required to file any of the excise tax forms listed above (see Employment tax and certain excise taxes earlier). Free income tax service See Form SS-4, Application for Employer Identification Number, for information on applying for an EIN. Free income tax service Change in default classification. Free income tax service   If a single-member LLC classified as a disregarded entity for income tax purposes acquires an additional member, it becomes a partnership under Regulations section 301. Free income tax service 7701-3(f)(2). Free income tax service However, if the LLC has made an election to be classified as a corporation (discussed later) and that elective classification is in effect at the time of the change in membership, the default classification as a partnership will not apply. Free income tax service   Other tax consequences of a change in membership, such as recognition of gain or loss, are determined by the transactions through which an interest in the LLC is acquired or disposed of. Free income tax service If a disregarded entity that becomes a partnership as a result of an increase in the number of members makes an election to be classified as a corporation, the applicable deemed transactions discussed in Subsequent Elections, later, apply. Free income tax service Example 4. Free income tax service Bart, who is not related to Alain, buys 50% of Alain's interest in an LLC that is a disregarded entity for $5,000. Free income tax service Alain does not contribute any portion of the $5,000 to the LLC. Free income tax service Alain and Bart continue to operate the business of the LLC as co-owners of the LLC. Free income tax service The LLC is converted to a partnership when the new member, Bart, buys an interest in the disregarded entity from the owner, Alain. Free income tax service Bart's buying a 50% interest in Alain's ownership interest in the LLC is treated as Bart's buying a 50% interest in each of the LLC's assets, which are treated as owned directly by Alain for federal income tax purposes. Free income tax service Immediately thereafter, Alain and Bart are treated as contributing their respective interests in those assets to a partnership in exchange for ownership interests in the partnership. Free income tax service Alain recognizes gain or loss from the deemed sale to Bart of the 50% interest in the assets. Free income tax service Neither Alain nor Bart recognizes any gain or loss as a result of the deemed contribution of the assets to the partnership. Free income tax service Example 5. Free income tax service Charles, who is not related to Danielle, contributes $10,000 to an LLC owned by Danielle for a 50% ownership interest in the LLC. Free income tax service The LLC uses all of the contributed cash in its business. Free income tax service Charles and Danielle continue to operate the business of the LLC as co-owners of the LLC. Free income tax service The LLC is converted from a disregarded entity to a partnership when Charles contributes cash to the LLC. Free income tax service Charles's contribution is treated as a contribution to a partnership in exchange for an ownership interest in the partnership. Free income tax service Danielle is treated as contributing all of the assets of the LLC to the partnership in exchange for a partnership interest. Free income tax service Neither Charles nor Danielle recognizes gain or loss as a result of the conversion of the disregarded entity to a partnership. Free income tax service   For more details on the preceding two examples, see Revenue Ruling 99-5, 1999-6 I. Free income tax service R. Free income tax service B. Free income tax service 8. Free income tax service You can find Revenue Ruling 99-5 at www. Free income tax service irs. Free income tax service gov/pub/irs-irbs/irb99-06. Free income tax service pdf. Free income tax service LLCs Classified as Corporations An LLC with either a single member or more than one member can elect to be classified as a corporation rather than be classified as a partnership or disregarded entity under the default rules discussed earlier. Free income tax service File Form 8832, Entity Classification Election, to elect classification as a C corporation. Free income tax service File Form 2553, Election by a Small Business Corporation, to elect classification as an S corporation. Free income tax service LLCs electing classification as an S corporation are not required to file Form 8832 to elect classification as a corporation before filing Form 2553. Free income tax service By filing Form 2553, an LLC is deemed to have elected classification as a corporation in addition to the S corporation classification. Free income tax service If the LLC elects to be classified as a corporation by filing Form 8832, a copy of the LLC's Form 8832 must be attached to the federal income tax return of each direct and indirect owner of the LLC for the tax year of the owner that includes the date on which the election took effect. Free income tax service Example 6. Free income tax service Classification as a corporation without an S election. Free income tax service Wanda and Sylvester are members of an LLC. Free income tax service They agree that the LLC should be classified as a corporation but do not want to elect to have the LLC be treated as an S corporation. Free income tax service The LLC must file Form 8832. Free income tax service Example 7. Free income tax service Classification as a corporation with an S election. Free income tax service Evelyn and Carol are members of an LLC. Free income tax service They agree that the LLC should be classified as an S corporation. Free income tax service The LLC must file Form 2553 instead of Form 8832. Free income tax service If the LLC is classified as a corporation, it must file a corporation income tax return. Free income tax service If it is a C corporation, it is taxed on its taxable income and distributions to the members are includible in the members' gross income to the extent of the corporation's earnings and profits (double taxation). Free income tax service If it is an S corporation, the corporation is generally not subject to any income tax and the income, deductions, gains, losses, and credits of the corporation “pass through” to the members. Free income tax service Corporations generally file either: Form 1120, U. Free income tax service S. Free income tax service Corporation Income Tax Return; or Form 1120S, U. Free income tax service S. Free income tax service Income Tax Return for an S Corporation. Free income tax service For more information on the income taxation of corporations and their shareholders, see Publication 542, Corporations. Free income tax service For more information on the income taxation of S corporations and their shareholders, see the Instructions for Form 1120S, U. Free income tax service S. Free income tax service Income Tax Return for an S Corporation. Free income tax service Subsequent Elections An LLC can elect to change its classification. Free income tax service Generally, once an LLC has elected to change its classification, it cannot elect again to change it classification during the 60 months after the effective date of the election. Free income tax service An election by a newly formed LLC that is effective on the date of formation is not considered a change for purposes of this limitation. Free income tax service For more information and exceptions, see Regulations section 301. Free income tax service 7701-3(c) and the Form 8832 instructions. Free income tax service An election to change classification can have significant tax consequences based on the following transactions that are deemed to occur as a result of the election. Free income tax service Partnership to corporation. Free income tax service   An election to change classification from a partnership to a corporation will be treated as if the partnership contributed all of its assets and liabilities to the corporation in exchange for stock and the partnership then immediately liquidated by distributing the stock to its partners. Free income tax service   For more information, see Partnership Distributions in Publication 541 and Property Exchanged for Stock in Publication 542. Free income tax service Corporation to partnership. Free income tax service   An election to change classification from a corporation to a partnership will be treated as if the corporation distributed all of its assets and liabilities to its shareholders in liquidation and the shareholders then immediately contributed all of the distributed assets and liabilities to a new partnership. Free income tax service   For more information, see Contribution of Property in Publication 541 and Distributions to Shareholders in Publication 542. Free income tax service Corporation to disregarded entity. Free income tax service   An election to change classification from a corporation to a disregarded entity will be treated as if the corporation distributed all of its assets and liabilities to its single owner in liquidation. Free income tax service   For more information, see Distributions to Shareholders in Publication 542. Free income tax service Disregarded entity to corporation. Free income tax service   An election to change classification from a disregarded entity to a corporation will be treated as if the owner of the disregarded entity contributed all of the assets and liabilities to the corporation in exchange for stock. Free income tax service   For more information, see Property Exchanged for Stock in Publication 542. Free income tax service How To Get More Information This section describes the help the IRS and other federal agencies offer to taxpayers who operate their own businesses. Free income tax service Internal Revenue Service You can get help with unresolved tax issues, order free publications and forms, ask tax questions, and get information from the IRS in several ways. Free income tax service By selecting the method that is best for you, you will have quick and easy access to tax help. Free income tax service Contacting your Taxpayer Advocate. Free income tax service   The Taxpayer Advocate Service (TAS) is an independent organization within the IRS whose employees assist taxpayers who are experiencing economic harm, who are seeking help in resolving tax problems that have not been resolved through normal channels, or who believe that an IRS system or procedure is not working as it should. Free income tax service   You can contact the TAS by calling the TAS toll-free case intake line at 1-877-777-4778 or TTY/TDD 1-800-829-4059 to see if you are eligible for assistance. Free income tax service You can also call or write to your local taxpayer advocate, whose phone number and address are listed in your local telephone directory and in Publication 1546, Taxpayer Advocate Service — Your Voice at the IRS. Free income tax service You can file Form 911, Request for Taxpayer Advocate Service Assistance (And Application for Taxpayer Assistance Order), or ask an IRS employee to complete it on your behalf. Free income tax service For more information, go to www. Free income tax service irs. Free income tax service gov/advocate. Free income tax service Low Income Taxpayer Clinics (LITCs). Free income tax service   LITCs are independent organizations that provide low income taxpayers with representation in federal tax controversies with the IRS for free or for a nominal charge. Free income tax service The clinics also provide tax education and outreach for taxpayers with limited English proficiency or who speak English as a second language. Free income tax service Publication 4134, Low Income Taxpayer Clinic List, provides information on clinics in your area. Free income tax service It is available at www. Free income tax service irs. Free income tax service gov or at your local IRS office. Free income tax service Small business workshops. Free income tax service   Small business workshops are designed to help the small business owner understand and fulfill their federal tax responsibilities. Free income tax service Workshops are sponsored and presented by IRS partners who are federal tax specialists. Free income tax service Workshop topics vary from a general overview of taxes to more specific topics such as recordkeeping and retirement plans. Free income tax service Although most are free, some workshops have fees associated with them. Free income tax service Any fees charged for a workshop are paid to the sponsoring organization, not the IRS. Free income tax service   For more information, visit www. Free income tax service irs. Free income tax service gov/businesses/small. Free income tax service Subscribe to e-news for small businesses. Free income tax service   Join the e-News for Small Businesses mailing list to receive updates, reminders, and other information useful to small business owners and self employed individuals. Free income tax service Visit the website at www. Free income tax service irs. Free income tax service gov/businesses/small and click on “Subscribe to e-News. Free income tax service ” Free tax services. Free income tax service   To find out what services are available, get Publication 910, IRS Guide to Free Tax Services. Free income tax service It contains a list of free tax publications and describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics. Free income tax service   Accessible versions of IRS published products are available on request in a variety of alternative formats for people with disabilities. Free income tax service Internet. Free income tax service You can access the IRS website at www. Free income tax service irs. Free income tax service gov 24 hours a day, 7 days a week, to: E-file your return. Free income tax service Find out about commercial tax preparation and e-file services available free to eligible taxpayers. Free income tax service Check the status of your refund. Free income tax service Go to www. Free income tax service irs. Free income tax service gov and click on Where's My Refund. Free income tax service Wait at least 72 hours after the IRS acknowledges receipt of your e-filed return, or 3 to 4 weeks after mailing a paper return. Free income tax service If you filed Form 8379 with your return, wait 14 weeks (11 weeks if you filed electronically). Free income tax service Have your tax return available so you can provide your social security number, your filing status, and the exact whole dollar amount of your refund. Free income tax service Download forms, instructions, and publications. Free income tax service Order IRS products online. Free income tax service Research your tax questions online. Free income tax service Search publications online by topic or keyword. Free income tax service View Internal Revenue Bulletins (IRBs) published in the last few years. Free income tax service Figure your withholding allowances using the withholding calculator online at www. Free income tax service irs. Free income tax service gov/individuals. Free income tax service Determine if Form 6251 must be filed using our Alternative Minimum Tax (AMT) Assistant. Free income tax service Sign up to receive local and national tax news by email. Free income tax service Get information on starting and operating a small business. Free income tax service Phone. Free income tax service Many services are available by phone. Free income tax service Ordering forms, instructions, and publications. Free income tax service Call 1-800-829-3676 to order current-year forms, instructions, and publications, and prior-year forms and instructions. Free income tax service You should receive your order within 10 days. Free income tax service Asking tax questions. Free income tax service Call the IRS with your tax questions at 1-800-829-1040. Free income tax service Solving problems. Free income tax service You can get face-to-face help solving tax problems every business day in IRS Taxpayer Assistance Centers. Free income tax service An employee can explain IRS letters, request adjustments to your account, or help you set up a payment plan. Free income tax service Call your local Taxpayer Assistance Center for an appointment. Free income tax service To find the number, go to www. Free income tax service irs. Free income tax service gov/localcontacts or look in the phone book under United States Government, Internal Revenue Service. Free income tax service TTY/TDD equipment. Free income tax service If you have access to TTY/TDD equipment, call 1-800-829-4059 to ask tax questions or to order forms and publications. Free income tax service TeleTax topics. Free income tax service Call 1-800-829-4477 to listen to pre-recorded messages covering various tax topics. Free income tax service Refund information. Free income tax service To check the status of your 2009 refund, call 1-800-829-1954 during business hours or 1-800-829-4477 (automated refund information 24 hours a day, 7 days a week). Free income tax service Wait at least 72 hours after the IRS acknowledges receipt of your e-filed return, or 3 to 4 weeks after mailing a paper return. Free income tax service If you filed Form 8379 with your return, wait 14 weeks (11 weeks if you filed electronically). Free income tax service Have your 2009 tax return available so you can provide your social security number, your filing status, and the exact whole dollar amount of your refund. Free income tax service Refunds are sent out weekly on Fridays. Free income tax service If you check the status of your refund and are not given the date it will be issued, please wait until the next week before checking back. Free income tax service Evaluating the quality of our telephone services. Free income tax service To ensure IRS representatives give accurate, courteous, and professional answers, we use several methods to evaluate the quality of our telephone services. Free income tax service One method is for a second IRS representative to listen in on or record random telephone calls. Free income tax service Another is to ask some callers to complete a short survey at the end of the call. Free income tax service Walk-in. Free income tax service Many products and services are available on a walk-in basis. Free income tax service Products. Free income tax service You can walk in to many post offices, libraries, and IRS offices to pick up certain forms, instructions, and publications. Free income tax service Some IRS offices, libraries, grocery stores, copy centers, city and county government offices, credit unions, and office supply stores have a collection of products available to print from a CD or photocopy from reproducible proofs. Free income tax service Also, some IRS offices and libraries have the Internal Revenue Code, regulations, Internal Revenue Bulletins, and Cumulative Bulletins available for research purposes. Free income tax service Services. Free income tax service You can walk in to your local Taxpayer Assistance Center every business day for personal, face-to-face tax help. Free income tax service An employee can explain IRS letters, request adjustments to your tax account, or help you set up a payment plan. Free income tax service If you need to resolve a tax problem, have questions about how the tax law applies to your individual tax return, or you are more comfortable talking with someone in person, visit your local Taxpayer Assistance Center where you can spread out your records and talk with an IRS representative face-to-face. Free income tax service No appointment is necessary—just walk in. Free income tax service If you prefer, you can call your local Center and leave a message requesting an appointment to resolve a tax account issue. Free income tax service A representative will call you back within 2 business days to schedule an in-person appointment at your convenience. Free income tax service If you have an ongoing, complex tax account problem or a special need, such as a disability, an appointment can be requested. Free income tax service All other issues will be handled without an appointment. Free income tax service To find the number of your local office, go to www. Free income tax service irs. Free income tax service gov/localcontacts or look in the phone book under United States Government, Internal Revenue Service. Free income tax service Mail. Free income tax service You can send your order for forms, instructions, and publications to the address below. Free income tax service You should receive a response within 10 days after your request is received. Free income tax service Internal Revenue Service1201 N. Free income tax service Mitsubishi MotorwayBloomington, IL 61705–6613 DVD for tax products. Free income tax service You can order Publication 1796, IRS Tax Products DVD, and obtain: Current-year forms, instructions, and publications. Free income tax service Prior-year forms, instructions, and publications. Free income tax service Tax Map: an electronic research tool and finding aid. Free income tax service Tax law frequently asked questions. Free income tax service Tax Topics from the IRS telephone response system. Free income tax service Internal Revenue Code—Title 26 of the U. Free income tax service S. Free income tax service Code. Free income tax service Fill-in, print, and save features for most tax forms. Free income tax service Internal Revenue Bulletins. Free income tax service Toll-free and email technical support. Free income tax service Two releases during the year. Free income tax service – The first release will ship the beginning of January. Free income tax service – The final release will ship the beginning of March. Free income tax service Purchase the DVD from National Technical Information Service (NTIS) at www. Free income tax service irs. Free income tax service gov/cdorders for $30 (no handling fee) or call 1-877-CDFORMS (1-877-233-6767) toll free to buy the DVD for $30 (plus a $6 handling fee). Free income tax service Small Business Administration The Small Business Administration (SBA) offers training and educational programs, counseling services, financial programs, and contract assistance for small business owners. Free income tax service The SBA also has publications and videos on a variety of business topics. Free income tax service The following briefly describes assistance provided by the SBA. Free income tax service Small Business Development Centers (SBDCs). Free income tax service   SBDCs provide counseling, training, and technical services to current and prospective small business owners who cannot afford the services of a private consultant. Free income tax service Help is available when beginning, improving, or expanding a small business. Free income tax service Business Information Centers (BICs). Free income tax service   BICs offer a small business reference library, management video tapes, and computer technology to help plan a business. Free income tax service BICs also offer one-on-one assistance. Free income tax service Individuals who are in business or are interested in starting a business can use BICs as often as they wish at no charge. Free income tax service Service Corps of Retired Executives (SCORE). Free income tax service   SCORE provides small business counseling and training to current and prospective small business owners. Free income tax service SCORE is made up of current and former business people who offer their expertise and knowledge to help people start, manage, and expand a small business. Free income tax service SCORE also offers a variety of small business workshops. Free income tax service    Internet. Free income tax service You can visit the SBA website at www. Free income tax service sba. Free income tax service gov. Free income tax service While visiting the SBA website, you can find a variety of information of interest to small business owners. Free income tax service    Phone. Free income tax service Call the SBA Answer Desk at 1-800-UASK-SBA (1-800-827-5722) for general information about programs available to assist small business owners. Free income tax service    Walk-in. Free income tax service You can walk in to a Small Business Development Center or Business Information Center to request assistance with your small business. Free income tax service To find the location nearest you, visit the SBA website or call the SBA Answer Desk. Free income tax service Other Federal Agencies Other federal agencies also publish publications and pamphlets to assist small businesses. Free income tax service Most of these are available from the Superintendent of Documents at the Government Printing Office. Free income tax service You can get information and order these publications and pamphlets in several ways. Free income tax service Internet. Free income tax service You can visit the GPO website at www. Free income tax service access. Free income tax service gpo. Free income tax service gov. Free income tax service Mail. Free income tax service Write to the GPO at the following address. Free income tax service Superintendent of DocumentsU. Free income tax service S. Free income tax service Government Printing OfficeP. Free income tax service O. Free income tax service Box 979050St. Free income tax service Louis, MO 63917-9000 Phone. Free income tax service Call the GPO toll-free at 1-866-512-1800 or at 202-512-1800 from the Washington, DC area. Free income tax service Prev  Up  Next   Home   More Online Publications
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Page Last Reviewed or Updated: 28-Mar-2014

The Free Income Tax Service

Free income tax service 1. Free income tax service   Rental Income and Expenses (If No Personal Use of Dwelling) Table of Contents Rental IncomeWhen To Report Types of Income Rental ExpensesWhen To Deduct Types of Expenses This chapter discusses the various types of rental income and expenses for a residential rental activity with no personal use of the dwelling. Free income tax service Generally, each year you will report all income and deduct all out-of-pocket expenses in full. Free income tax service The deduction to recover the cost of your rental property—depreciation—is taken over a prescribed number of years, and is discussed in chapter 2, Depreciation of Rental Property. Free income tax service If your rental income is from property you also use personally or rent to someone at less than a fair rental price, first read the information in chapter 5 , Personal Use of Dwelling Unit (Including Vacation Home). Free income tax service Rental Income In most cases, you must include in your gross income all amounts you receive as rent. Free income tax service Rental income is any payment you receive for the use or occupation of property. Free income tax service In addition to amounts you receive as normal rental payments, there are other amounts that may be rental income. Free income tax service When To Report When you report rental income on your tax return generally depends on whether you are a cash basis taxpayer or use an accrual method. Free income tax service Most individual taxpayers use the cash method. Free income tax service Cash method. Free income tax service   You are a cash basis taxpayer if you report income on your return in the year you actually or constructively receive it, regardless of when it was earned. Free income tax service You constructively receive income when it is made available to you, for example, by being credited to your bank account. Free income tax service Accrual method. Free income tax service    If you are an accrual basis taxpayer, you generally report income when you earn it, rather than when you receive it. Free income tax service You generally deduct your expenses when you incur them, rather than when you pay them. Free income tax service More information. Free income tax service   See Publication 538, Accounting Periods and Methods, for more information about when you constructively receive income and accrual methods of accounting. Free income tax service Types of Income The following are common types of rental income. Free income tax service Advance rent. Free income tax service   Advance rent is any amount you receive before the period that it covers. Free income tax service Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use. Free income tax service Example. Free income tax service On March 18, 2013, you signed a 10-year lease to rent your property. Free income tax service During 2013, you received $9,600 for the first year's rent and $9,600 as rent for the last year of the lease. Free income tax service You must include $19,200 in your rental income in the first year. Free income tax service Canceling a lease. Free income tax service   If your tenant pays you to cancel a lease, the amount you receive is rent. Free income tax service Include the payment in your income in the year you receive it regardless of your method of accounting. Free income tax service Expenses paid by tenant. Free income tax service   If your tenant pays any of your expenses, those payments are rental income. Free income tax service Because you must include this amount in income, you can also deduct the expenses if they are deductible rental expenses. Free income tax service For more information, see Rental Expenses , later. Free income tax service Example 1. Free income tax service Your tenant pays the water and sewage bill for your rental property and deducts the amount from the normal rent payment. Free income tax service Under the terms of the lease, your tenant does not have to pay this bill. Free income tax service Include the utility bill paid by the tenant and any amount received as a rent payment in your rental income. Free income tax service You can deduct the utility payment made by your tenant as a rental expense. Free income tax service Example 2. Free income tax service While you are out of town, the furnace in your rental property stops working. Free income tax service Your tenant pays for the necessary repairs and deducts the repair bill from the rent payment. Free income tax service Include the repair bill paid by the tenant and any amount received as a rent payment in your rental income. Free income tax service You can deduct the repair payment made by your tenant as a rental expense. Free income tax service Property or services. Free income tax service   If you receive property or services as rent, instead of money, include the fair market value of the property or services in your rental income. Free income tax service   If the services are provided at an agreed upon or specified price, that price is the fair market value unless there is evidence to the contrary. Free income tax service Example. Free income tax service Your tenant is a house painter. Free income tax service He offers to paint your rental property instead of paying 2 months rent. Free income tax service You accept his offer. Free income tax service Include in your rental income the amount the tenant would have paid for 2 months rent. Free income tax service You can deduct that same amount as a rental expense for painting your property. Free income tax service Security deposits. Free income tax service   Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. Free income tax service But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year. Free income tax service    If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Free income tax service Include it in your income when you receive it. Free income tax service Other Sources of Rental Income Lease with option to buy. Free income tax service   If the rental agreement gives your tenant the right to buy your rental property, the payments you receive under the agreement are generally rental income. Free income tax service If your tenant exercises the right to buy the property, the payments you receive for the period after the date of sale are considered part of the selling price. Free income tax service Part interest. Free income tax service   If you own a part interest in rental property, you must report your part of the rental income from the property. Free income tax service Rental of property also used as your home. Free income tax service   If you rent property that you also use as your home and you rent it less than 15 days during the tax year, do not include the rent you receive in your income and do not deduct rental expenses. Free income tax service However, you can deduct on Schedule A (Form 1040), Itemized Deductions, the interest, taxes, and casualty and theft losses that are allowed for nonrental property. Free income tax service See chapter 5, Personal Use of Dwelling Unit (Including Vacation Home). Free income tax service Rental Expenses In most cases, the expenses of renting your property, such as maintenance, insurance, taxes, and interest, can be deducted from your rental income. Free income tax service Personal use of rental property. Free income tax service   If you sometimes use your rental property for personal purposes, you must divide your expenses between rental and personal use. Free income tax service Also, your rental expense deductions may be limited. Free income tax service See chapter 5, Personal Use of Dwelling Unit (Including Vacation Home). Free income tax service Part interest. Free income tax service   If you own a part interest in rental property, you can deduct expenses you paid according to your percentage of ownership. Free income tax service Example. Free income tax service Roger owns a one-half undivided interest in a rental house. Free income tax service Last year he paid $968 for necessary repairs on the property. Free income tax service Roger can deduct $484 (50% × $968) as a rental expense. Free income tax service He is entitled to reimbursement for the remaining half from the co-owner. Free income tax service When To Deduct You generally deduct your rental expenses in the year you pay them. Free income tax service If you use the accrual method, see Publication 538 for more information. Free income tax service Types of Expenses Listed below are the most common rental expenses. Free income tax service Advertising. Free income tax service Auto and travel expenses. Free income tax service Cleaning and maintenance. Free income tax service Commissions. Free income tax service Depreciation. Free income tax service Insurance. Free income tax service Interest (other). Free income tax service Legal and other professional fees. Free income tax service Local transportation expenses. Free income tax service Management fees. Free income tax service Mortgage interest paid to banks, etc. Free income tax service Points. Free income tax service Rental payments. Free income tax service Repairs. Free income tax service Taxes. Free income tax service Utilities. Free income tax service Some of these expenses, as well as other less common ones, are discussed below. Free income tax service Depreciation. Free income tax service   Depreciation is a capital expense. Free income tax service It is the mechanism for recovering your cost in an income producing property and must be taken over the expected life of the property. Free income tax service   You can begin to depreciate rental property when it is ready and available for rent. Free income tax service See Placed in Service under When Does Depreciation Begin and End in chapter 2. Free income tax service Insurance premiums paid in advance. Free income tax service   If you pay an insurance premium for more than one year in advance, for each year of coverage you can deduct the part of the premium payment that will apply to that year. Free income tax service You cannot deduct the total premium in the year you pay it. Free income tax service See chapter 6 of Publication 535 for information on deductible premiums. Free income tax service Interest expense. Free income tax service   You can deduct mortgage interest you pay on your rental property. Free income tax service When you refinance a rental property for more than the previous outstanding balance, the portion of the interest allocable to loan proceeds not related to rental use generally cannot be deducted as a rental expense. Free income tax service Chapter 4 of Publication 535 explains mortgage interest in detail. Free income tax service Expenses paid to obtain a mortgage. Free income tax service   Certain expenses you pay to obtain a mortgage on your rental property cannot be deducted as interest. Free income tax service These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses that are part of your basis in the property. Free income tax service Form 1098, Mortgage Interest Statement. Free income tax service   If you paid $600 or more of mortgage interest on your rental property to any one person, you should receive a Form 1098 or similar statement showing the interest you paid for the year. Free income tax service If you and at least one other person (other than your spouse if you file a joint return) were liable for, and paid interest on, the mortgage, and the other person received the Form 1098, report your share of the interest on Schedule E (Form 1040), line 13. Free income tax service Attach a statement to your return showing the name and address of the other person. Free income tax service On the dotted line next to line 13, enter “See attached. Free income tax service ” Legal and other professional fees. Free income tax service   You can deduct, as a rental expense, legal and other professional expenses such as tax return preparation fees you paid to prepare Schedule E, Part I. Free income tax service For example, on your 2013 Schedule E you can deduct fees paid in 2013 to prepare Part I of your 2012 Schedule E. Free income tax service You can also deduct, as a rental expense, any expense (other than federal taxes and penalties) you paid to resolve a tax underpayment related to your rental activities. Free income tax service Local benefit taxes. Free income tax service   In most cases, you cannot deduct charges for local benefits that increase the value of your property, such as charges for putting in streets, sidewalks, or water and sewer systems. Free income tax service These charges are nondepreciable capital expenditures and must be added to the basis of your property. Free income tax service However, you can deduct local benefit taxes that are for maintaining, repairing, or paying interest charges for the benefits. Free income tax service Local transportation expenses. Free income tax service   You may be able to deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property. Free income tax service However, transportation expenses incurred to travel between your home and a rental property generally constitute nondeductible commuting costs unless you use your home as your principal place of business. Free income tax service See Publication 587, Business Use of Your Home, for information on determining if your home office qualifies as a principal place of business. Free income tax service   Generally, if you use your personal car, pickup truck, or light van for rental activities, you can deduct the expenses using one of two methods: actual expenses or the standard mileage rate. Free income tax service For 2013, the standard mileage rate for business use is 56. Free income tax service 5 cents per mile. Free income tax service For more information, see chapter 4 of Publication 463. Free income tax service    To deduct car expenses under either method, you must keep records that follow the rules in chapter 5 of Publication 463. Free income tax service In addition, you must complete Form 4562, Part V, and attach it to your tax return. Free income tax service Pre-rental expenses. Free income tax service   You can deduct your ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available for rent. Free income tax service Rental of equipment. Free income tax service   You can deduct the rent you pay for equipment that you use for rental purposes. Free income tax service However, in some cases, lease contracts are actually purchase contracts. Free income tax service If so, you cannot deduct these payments. Free income tax service You can recover the cost of purchased equipment through depreciation. Free income tax service Rental of property. Free income tax service   You can deduct the rent you pay for property that you use for rental purposes. Free income tax service If you buy a leasehold for rental purposes, you can deduct an equal part of the cost each year over the term of the lease. Free income tax service Travel expenses. Free income tax service   You can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip is to collect rental income or to manage, conserve, or maintain your rental property. Free income tax service You must properly allocate your expenses between rental and nonrental activities. Free income tax service You cannot deduct the cost of traveling away from home if the primary purpose of the trip is to improve the property. Free income tax service The cost of improvements is recovered by taking depreciation. Free income tax service For information on travel expenses, see chapter 1 of Publication 463. Free income tax service    To deduct travel expenses, you must keep records that follow the rules in chapter 5 of Publication 463. Free income tax service Uncollected rent. Free income tax service   If you are a cash basis taxpayer, do not deduct uncollected rent. Free income tax service Because you have not included it in your income, it is not deductible. Free income tax service   If you use an accrual method, report income when you earn it. Free income tax service If you are unable to collect the rent, you may be able to deduct it as a business bad debt. Free income tax service See chapter 10 of Publication 535 for more information about business bad debts. Free income tax service Vacant rental property. Free income tax service   If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining the property while the property is vacant. Free income tax service However, you cannot deduct any loss of rental income for the period the property is vacant. Free income tax service Vacant while listed for sale. Free income tax service   If you sell property you held for rental purposes, you can deduct the ordinary and necessary expenses for managing, conserving, or maintaining the property until it is sold. Free income tax service If the property is not held out and available for rent while listed for sale, the expenses are not deductible rental expenses. Free income tax service Points The term “points” is often used to describe some of the charges paid, or treated as paid, by a borrower to take out a loan or a mortgage. Free income tax service These charges are also called loan origination fees, maximum loan charges, or premium charges. Free income tax service Any of these charges (points) that are solely for the use of money are interest. Free income tax service Because points are prepaid interest, you generally cannot deduct the full amount in the year paid, but must deduct the interest over the term of the loan. Free income tax service The method used to figure the amount of points you can deduct each year follows the original issue discount (OID) rules. Free income tax service In this case, points are equivalent to OID, which is the difference between: The amount borrowed (redemption price at maturity, or principal) and The proceeds (issue price). Free income tax service The first step is to determine whether your total OID (which you may have on bonds or other investments in addition to the mortgage loan), including the OID resulting from the points, is insignificant or de minimis. Free income tax service If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct. Free income tax service De minimis OID. Free income tax service   The OID is de minimis if it is less than one-fourth of 1% (. Free income tax service 0025) of the stated redemption price at maturity (principal amount of the loan) multiplied by the number of full years from the date of original issue to maturity (term of the loan). Free income tax service   If the OID is de minimis, you can choose one of the following ways to figure the amount of points you can deduct each year. Free income tax service On a constant-yield basis over the term of the loan. Free income tax service On a straight line basis over the term of the loan. Free income tax service In proportion to stated interest payments. Free income tax service In its entirety at maturity of the loan. Free income tax service You make this choice by deducting the OID (points) in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued. Free income tax service Example. Free income tax service Carol Madison took out a $100,000 mortgage loan on January 1, 2013, to buy a house she will use as a rental during 2013. Free income tax service The loan is to be repaid over 30 years. Free income tax service During 2013, Carol paid $10,000 of mortgage interest (stated interest) to the lender. Free income tax service When the loan was made, she paid $1,500 in points to the lender. Free income tax service The points reduced the principal amount of the loan from $100,000 to $98,500, resulting in $1,500 of OID. Free income tax service Carol determines that the points (OID) she paid are de minimis based on the following computation. Free income tax service Redemption price at maturity (principal amount of the loan) $100,000 Multiplied by: The term of the  loan in complete years ×30 Multiplied by ×. Free income tax service 0025 De minimis amount $7,500 The points (OID) she paid ($1,500) are less than the de minimis amount ($7,500). Free income tax service Therefore, Carol has de minimis OID and she can choose one of the four ways discussed earlier to figure the amount she can deduct each year. Free income tax service Under the straight line method, she can deduct $50 each year for 30 years. Free income tax service Constant-yield method. Free income tax service   If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. Free income tax service   You figure your deduction for the first year in the following manner. Free income tax service Determine the issue price of the loan. Free income tax service If you paid points on the loan, the issue price generally is the difference between the principal and the points. Free income tax service Multiply the result in (1) by the yield to maturity (defined later). Free income tax service Subtract any qualified stated interest payments (defined later) from the result in (2). Free income tax service This is the OID you can deduct in the first year. Free income tax service Yield to maturity (YTM). Free income tax service   This rate is generally shown in the literature you receive from your lender. Free income tax service If you do not have this information, consult your lender or tax advisor. Free income tax service In general, the YTM is the discount rate that, when used in computing the present value of all principal and interest payments, produces an amount equal to the principal amount of the loan. Free income tax service Qualified stated interest (QSI). Free income tax service   In general, this is the stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a fixed rate. Free income tax service Example—Year 1. Free income tax service The facts are the same as in the previous example. Free income tax service The yield to maturity on Carol's loan is 10. Free income tax service 2467%, compounded annually. Free income tax service She figured the amount of points (OID) she could deduct in 2013 as follows. Free income tax service Principal amount of the loan $100,000 Minus: Points (OID) –1,500 Issue price of the loan $98,500 Multiplied by: YTM × . Free income tax service 102467 Total 10,093 Minus: QSI –10,000 Points (OID) deductible in 2013 $93 To figure your deduction in any subsequent year, you start with the adjusted issue price. Free income tax service To get the adjusted issue price, add to the issue price figured in Year 1 any OID previously deducted. Free income tax service Then follow steps (2) and (3), earlier. Free income tax service Example—Year 2. Free income tax service Carol figured the deduction for 2014 as follows. Free income tax service Issue price $98,500 Plus: Points (OID) deducted  in 2013 +93 Adjusted issue price $98,593 Multiplied by: YTM × . Free income tax service 102467 Total 10,103 Minus: QSI –10,000 Points (OID) deductible in 2014 $103 Loan or mortgage ends. Free income tax service    If your loan or mortgage ends, you may be able to deduct any remaining points (OID) in the tax year in which the loan or mortgage ends. Free income tax service A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. Free income tax service However, if the refinancing is with the same lender, the remaining points (OID) generally are not deductible in the year in which the refinancing occurs, but may be deductible over the term of the new mortgage or loan. Free income tax service Points when loan refinance is more than the previous outstanding balance. Free income tax service   When you refinance a rental property for more than the previous outstanding balance, the portion of the points allocable to loan proceeds not related to rental use generally cannot be deducted as a rental expense. Free income tax service For example, if an individual refinanced a loan with a balance of $100,000, the amount of the new loan was $120,000, and the taxpayer used $20,000 to purchase a car, points allocable to the $20,000 would be treated as nondeductible personal interest. Free income tax service Repairs and Improvements Generally, an expense for repairing or maintaining your rental property may be deducted if you are not required to capitalize the expense. Free income tax service Improvements. Free income tax service   You must capitalize any expense you pay to improve your rental property. Free income tax service An expense is for an improvement if it results in a betterment to your property, restores your property, or adapts your property to a new or different use. Free income tax service Betterments. Free income tax service   Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property. Free income tax service Restoration. Free income tax service   Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition. Free income tax service Adaptation. Free income tax service   Expenses that may be for adaptation include expenses for altering your property to a use that is not consistent with the intended ordinary use of your property when you began renting the property. Free income tax service Separate the costs of repairs and improvements, and keep accurate records. Free income tax service You will need to know the cost of improvements when you sell or depreciate your property. Free income tax service The expenses you capitalize for improving your property can generally be depreciated as if the improvement were separate property. Free income tax service Table 1-1. Free income tax service Examples of Improvements Additions Bedroom Bathroom Deck Garage Porch Patio  Lawn & Grounds Landscaping Driveway Walkway Fence Retaining wall Sprinkler system Swimming pool Miscellaneous Storm windows, doors New roof Central vacuum Wiring upgrades Satellite dish Security system   Heating & Air Conditioning Heating system Central air conditioning Furnace Duct work Central humidifier Filtration system Plumbing Septic system Water heater Soft water system Filtration system  Interior Improvements Built-in appliances Kitchen modernization Flooring Wall-to-wall carpeting  Insulation Attic Walls, floor Pipes, duct work Prev  Up  Next   Home   More Online Publications