Owning and maintaining rental property can often be a challenging and rewarding task for landlords.
Let’s face it; there are a lot of elements to manage, from qualifying renters to property maintenance and upgrades. The last topic most landlords consider during the year are the tax implications of their rental properties. Little thought is given to how rental income should be reported and what to do with advance rent and expenses paid by the tenant. However, how these are handled will have an impact on the tax benefit received at the end of the year. To help rental property owners understand key tax issues, Hanson & Co. CPAs has provided a list of the key rental income issues to consider below.
Rental Income Reporting
There is often confusion among landlords as to what transaction qualified as rental income. To be clear, the IRS defines rental income as payment received for the use or occupation of property. Generally all amounts collected as rent must be included in your gross income and should be reported in the year received. When a property is rented, expenses are almost always incurred by the landlord. These expenses can be deducted from your gross rental income and should be deducted in the year they are paid. This includes expenses incurred if you rent a condominium or cooperative apartment, if you rent part of your property, or if you change your property to rental use. Several examples of rental income that must be reported are as follows:
- Advance Rent – Advance rent is any amount you receive before the period that it covers. 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.
- Security Deposits – 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. 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. (If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Include it in your income when you receive it.)
- Expenses Paid by the Tenant – If your tenant pays any of your expenses, the payments are rental income and this income must be included in your rental income. You can however, deduct the expenses if they are classified as deductible rental expenses. Several examples are included below.
Example One: Your tenant pays the water and sewage bill for your rental property and deducts it from the normal rent payment. Under the terms of the lease, your tenant does not have to pay this bill.
Example Two: While you are out of town, the furnace in your rental property stops working. Your tenant pays for the necessary repairs and deducts the repair bill from the rent payment.
- Property or Services in Lieu of Rent – If you receive property or services, instead of money, as rent, include the fair market value of the property or services in your rental income. 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.
- Personal Use of Vacation Home – If you have any personal use of a vacation home or other dwelling unit that you rent out, you must divide your expenses between rental use and personal use. If your expenses for rental use are more than your rental income, you may not be able to deduct all of the rental expenses.
The rules for reporting rental income can sometimes be confusing depending on your situation. For this reason, it’s essential to work with a tax advisor that understands the nuances of real estate tax. To learn more about rental property income and required report, please contact Marc Bradac, CPA at (303) 388-1010 or click here for email.