What is the correct tax treatment of Nate and Teddi's rental income and expenses?

The correct treatment of rental income and expenses hinges on how rental properties are classified and reported for tax purposes. In this scenario, stating that the other allocated rental expenses are limited to the gross rental income aligns with the fundamental principles of tax law regarding rental real estate.

Rental property owners can deduct ordinary and necessary expenses related to the rental activity, but the total deductions cannot exceed the rental income generated. In other words, if rental expenses surpass the income generated, the excess can generally not be deducted against other income, limiting deductions strictly to the amount of rental income earned.

This principle ensures that taxpayers cannot claim losses beyond what they actually earned from rental activities on their tax returns. Hence, if Nate and Teddi had limited rental income, any additional expenses would be confined to that income level.

While mortgage interest and property taxes can certainly provide deductions, stating that these can be fully deducted without considering income limits would contradict regulations that govern carrying losses from rental activities. Therefore, recognizing the limitation on allocated expenses to the gross rental income is crucial for accurate tax reporting.