The situation:
-Wrestling with my 2012 1040. Have filed for an extension.
-I'm not a real-estate professional or tax professional.
-Own two residential rental properties - #1, #2
-Both are rented at FMV rates to non-relatives.
-Purchased property #1 in 2005 as an investment to rent out.
-Property #2 was my home that was paid for and took out a mortgage on it to buy property #1.
-In 2007, moved to another state (where I'm renting a place to live) and converted property #2 to rental because I didn't want to give it up. Thought I might move back in some day.
-Property #1 has shown a profit on Schedule E for 6 years out of 8, including the first partial year (2005).
-Property #2 has been in the red on Schedule E for 4 years out of 6, thru 2012, including the first partial year (2007). Filed a Form 5213 in tax year 2010 to postpone a not-for-profit categorization. Not sure it does much. Loss is mainly because of interest on the mortgage I took out on #2 to purchase property #1.

The questions:
-Do I have to now start treating property #2 as not-for-profit on my 1040 for 2012 and report it in accordance with Pub 535, Chapter 1?
-How tolerant is the IRS about categorizing a property as not-for-profit? An accountant has said to me casually (i.e. not for a fee) that since I'm not a real estate professional, I don't need to change the status of property #2 and can continue reporting it as a Schedule E loss. Will the IRS call me on it if I do that?
-Could I (and the IRS) consider the two rentals as a "single activity" and avoid a not-for-profit categorization that way? The combined Schedule E net-net for the two properties has been in the red 3 years out of 8 but only 2 years of the past 6, including 2012. The properties were being reported in past years on two separate columns of the single Schedule E.

Thanks in advance.

#1There is a presumption that you are renting the property for profit if your rental income has been more than your rent expenses for 3 years out of a period of 5 consecutive years. If you are just starting to rent the property you can elect to have this presumption made after you complete the 5-year period. To make this election you need to file Form 5213 within 3 years from the due date for filing your tax return for the year you first rented the property. If you receive a notice from the IRS proposing to disallow your rent expense deductions, you must file Form 5213 within 60 days.So, if you use this form, it should be filed within 3 years(2014) of the due date of the return(2011) for your first year in rental activity.



#2I guess it depends; I guess you need to contact the IRS for more accurate info in detail. If your activity necessitates characterization as a hobby, then you need to group your hobby related exp into 3 categories. #1; any non-business related expenses explicitly allowed as personal deductions by the tax code, such as home mortgage interest or state taxes. #2: expenditures typically deducted when incurred in connection with a business or investment activity, such as advertising, office supplies or travel expenses. #3: consists solely of depreciation and amortization charges for assets used in the hobby activity.You need to report the results on your tax return. you must use Sch A of Form 1040 to report deductions for hobby expenses. The hobby activity rules do not impose any further limitations on category one deductions. However, you can only deduct category two expenses to the extent that hobby income exceeds category one deductions. Likewise, the tax code allows deductions for category three items only if a taxpayer has hobby income remaining after application of category one and two deductions. Further, you must report category two and three expenses as misc itemized deductions on Sch A of Form 1040, which effectively reduces the value of the deduction by 2 percent of total your income.






#3The IRS established a special procedure by which taxpayers can make a late election to treat all their real estate activities as a single activity for purposes of meeting material participation rules. Generally, rental activities are presumptively treated as passive, restricting taxpayers’ eligibility to recognize certain losses and credits. Some tax law provides an exception from the presumption for qualifying rental real estate activities, in the form of thresholds for the amount and type of personal services performed in rental trades or businesses involving real property in which the taxpayer materially participates. Each of the taxpayer’s real estate interests is treated as a separate activity for these tests; however, some tax law allows a qualifying taxpayer to elect to instead treat them as a single real estate activity.

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