If you’re a new property landlord or thinking about trying out this type of investment, you better become familiar with the related tax rules. Money earned from renting property, particularly real estate, such as room, home or apartment, is considered income. This makes it taxable at both the federal and state level. However, the amount that is taxed can be reduced by whatever you spend in the same tax year maintaining the property and keeping it rentable.
First off, you’re going to be required to report any rent income earned on your income taxes. If you run your renting or property as a business, then it will either be on Schedule C statement attached to your income tax filings or as a corporation filing. Most people use the Schedule C option if running a self-owned business as a landlord.
Rent can show up in multiple forms, which makes things a bit more complicated. Standard rent is what you paid for the time period someone borrows your property. So when a renter uses a property for the month of June, he pays a rent check on June 1 which is the income earned for the privilege to use the property. Advance rent, on the other hand, is a payment that covers are period of time into the future. In this kind of situation, the taxability applies on a cash basis in the month and tax year that the payment is made. So if the same renter pays for two years in advance, the income paid in January 2010 is taxable in the 2010 tax year, regardless if the tenant is in place through the end of 2011.
A deposit on the other hand is not income. A deposit is a security amount in case the tenant causes some damage while in the property. This allows the landlord to then deduct the damage cost from the deposit paid up front. When the money gets deducted for damage costs, it becomes income. But wait, why are the funds income if they are just restoring a damage expense? Don’t worry, the damage repair is deductible so the taxability and repair wash each other out mathematically.
In a barter situation, when some trades you skilled work or use of another property for their own rent, the landlord then treads into what is called fair market value. There are still taxes applicable even if no cash changes hands. Reported rental income on your tax filings have to include the fair market value of the bartered services or property given in lieu of paid rent.
Additionally, property expenses paid by a tenant can be an issue as well. Let’s say the toilet plugs up. Rather than wait for the landlord to get a contractor, the tenant wants to just pay for a plumber to fix it and deduct the cost from the rent owed on the next month. For the landlord, the cost paid by the tenant to benefit the property becomes part of the rent income earned. No wonder landlords aren’t keen on having tenants paying bills for them; it creates a paperwork nightmare just trying to keep up with the math for tax purposes.
As mentioned earlier, however, there are offsets to all this figures creating a tax liability. When the landlord has to pay for maintaining the property, insuring it from damage, property tax, and financing interest charges, all of these are deductible from the income earned. So when the rent income for the year is calculated, the landlord is well-served to subtract out all these issues before declaring what is truly taxable rent income. This said, every deduction should be documented. Don’t guess and don’t make up a number. If you get audited, you will need to be able to prove your figures to the penny.
The IRS provides far more information on the matter and how to treat taxable rental property with regards to federal taxes. Much of the detail is covered in Publication 527 – Residential Rental Property. You can download this manual from the IRS website on the Internet at www.irs.gov or by calling the Agency at 800-TAX-FORM (800-829-3676) and asking for a hardcopy. Whichever the case, make sure you have the right answers for your taxes before dipping in big to the rental game.
Sources:
IRS Publication 527 – Residential Rental Property