Tax Treatment of Rental Income
What Is Rental Income? Payments received from a person or entity that is using property owned by you are typically considered rental income. You must report in your gross income all income received as rent. If services are being performed by a person who is renting the property from you, the value of these services must be included as income to you, and reported on your tax return.
What About Advance Rent? Advance rent, that is rent received as so-called "next month's rent" is required to be reported by you on your return as income received in the year in which it is received, not the year it is to be credited.
What About Security Deposits? Security deposits are not considered income received under the Internal Revenue Code, if they are actually held in an account as a security deposit. If, however, some or all of this deposit is paid for damages to the property during the year, then this money is required to be considered in your gross income calculation for that year.
Several Other "Surprises." If a tenant pays any expenses that are expenses that you, as the property owner are required to pay, you must consider this amount as income to you and report it on your return. As one might expect, there is a large area of dispute as to whether the expenses are expenses a tenant is required to pay, or expenses required to be attributed to the landlord. Beware that the IRS will look at the lease in an attempt to make this distinction. Otherwise there are no general rules in this instance that can be reported with certainty.
Another surprise is if a tenant pays you to cancel a lease. Your tax professional may be required to help you determine if this amount may qualify as a deduction. If it cannot, you will be required by the Code to report this amount received as ordinary income.
Rental Expenses. You are permitted to deduct the expenses related to the property in the year that you incur these expenses. Such expenses include taxes, management fees, maintenance fees, and similar expenditures.
You are permitted to deduct the rental expenses incurred while the property is not being rented. The only requirement is that you must be able to prove that you held the property out for rental. You are not permitted to deduct the amount of rental income lost while the property is vacant.
Rental Repairs. In an area that is surely to be contested, you are permitted to deduct rental property repairs. However, as the next section indicates, you are not permitted to deduct rental property improvements.
Rental property repairs include those items that are generally understood to keep the property functioning properly. One general rule of thumb is to ask if the action taken will improve the value of the property. If it will it may not be considered a repair. Fixing existing items in the house are good examples of repairs, and can include toilets, plumbing, air conditioners, heaters and related items.
Rental Improvements. If an expense will improve the value of the property, or will prolong its life, it is generally considered to be an improvement. Improvements are not deductible as expenses, but may create an adjustment to the basis of your property, or may be depreciated under the Internal Revenue Code. The exact treatment of either of these is beyond the scope of this article, and if you are preparing to make a substantial improvement to your rental property, it might be best to obtain professional advice prior to making the improvement, if you can.
Some examples of improvements are :
- Additions of porches;
- Additions of rooms;
- Adding a pool;
- Widening a driveway and garage; and
- Adding wooden finishes to various rooms.
These are all examples of improvements, although there are a number of examples of expenses that may be more difficult to determine, without professional help.
A Number of Other Expenses Can Be Deducted. If you own rental property, you may want to seek professional help to maximize your tax burden. However, the following is a list of some of the expenses associated with rental property that can be deducted in some instances:
- Insurance premiums;
- Equipment rented to use on the premises;
- Charges for services provided on your rental property;
- Your driving expenses, if you must drive to manage the property or collect rent.
What About If You Rent Part of the Year and Use the Property Part of the Year? You should know that the Internal Revenue Code does provide for this situation, which is apparently more common in today's world. There are, however, a number of specific rules that depend upon the ratios of rental use versus personal use, and it would be wise to consult with a professional if you planned such a usage for your property.