Rental Income and Taxes
Property management is a fast-paced industry with many moving parts from screening potential tenants, managing current tenants, and maintaining property quality. Income tax and deductions for rental properties may not be the first thing on a landlord's mind, but there are tax benefits that may mean the difference between losing money and earning a profit on a rental property. If you are a landlord earning rental income from property management, you should know about rental income tax and potential tax deductions.
What Counts as Rental Income?
- Payments received for early lease termination
- Property services received (in lieu of rent)
- Rent paid in advance
- Security deposits kept
- Lease with option to buy
According to the National Multifamily Housing Council, in 2019, the US population was 320 million. 66 percent of which lived in homes that they owned. That infers there are about 107 million people who live in rented dwellings. Extrapolating further, this data suggests that there are many taxpayers who are rental property owners. With that in mind, let us review rules and tax treatments in common rental events.
It is standard operating procedure for property owners to give tenants an early out of their leasing contract at a reasonable cost. When such an event occurs, the lease cancellation penalty the tenant pays to the landlord is treated in that tax year as income.
In some situations, a landlord and tenant may set up an arrangement whereby the tenant performs some type of service or upkeep on the property for a reduction in the stated rent. In this case, the agreed upon value of service must be counted as rent/income by the landlord. For example, say the two parties agree that the tenant will paint the dwelling they are occupying. In exchange for doing this, the landlord will consider the following months' rent paid in full. In this scenario, the landlord would have to count that forfeited rent payment as income.
Advance Rent Payments
Rent paid in advanced must be counted in the calendar year it is received. Which sounds straightforward, but some property owners get tripped up if the payment straddles two years. For example, if a tenant who rents a dwelling in the north migrates to warmer climates and leaves in November and pays rent through March of the following year, the total amount must be counted in the calendar year received.
In some situations, Landlords will charge tenants a security deposit at the inception of the lease. How this money is treated is dependent on how it used. If the deposit is to be returned to the tenant at the end of leases minus any upkeep and repairs, there is no tax consequence when received. At the end of the lease, any portion not returned to the tenant is counted as income in the calendar year the deduction was made.
Additionally, if the deposit is to be used as the last months' rent, the payment is then treated as advanced rent, and treated as income when received.
Lease Purchase Agreements
If a property owner has tendered a contract to a tenant that affords the tenant the option to buy the property, all rents paid by the tenant must be treated as income. However, if the tenant decides to purchase the property, any payments made by the tenant to the landlord post sell are treated as part of the selling price of the property.
These are just a few tips to help current and aspiring rental property owners understand basic rules for how to treat rental income when it comes to taxes. As always, consult with your Private CFO® for information on your specific situations.