There are several scenarios and situations in which a taxpayer will purchase a dwelling (home, mobile home, condo, townhouse, etc) for the purpose of producing supplemental income and in some instances, concurrently providing a vacation home. These opportunities have become more prevalent in the past five years with the availability of “short” sales, bank foreclosures, declines in the market value of homes, the inability of many Americans to qualify for a mortgage for the purchase of a home (thereby being forced to rent), etc. Before you make an offer, start building, or applying for a loan, read IRS Publication 527  (“Residental Rental Property”)  before you sign on the dotted line.
If you meet all of the requirements, the income or loss from these activities will be reported on Schedule E (“Supplemental Income and Loss”) of your Federal Form 1040. There are many facts to be considered, including:
- “Advance Rent” payments from your tenants are included in the tax year in which you actually receive the money, and not the year or periods in which the payments cover;
- “Security Deposits”, which you receive from tenants to partially or fully cover your repair and cleaning costs after the tenants have vacated the premises may also have to be included as income, depending on the contract that you have with the tenants. These amounts are also a “liability” in your Balance Sheet accounts if there is a requirement for some or all of the funds to be returned to the tenant at the end of the rental or lease period; Â
- “Services in Lieu of Rent” If the tenants provide you with their services (cleaning your properties, handyman, plumbing, electrical, landscaping etc) then you’ll need to include the fair market value (what you would have actually had to pay someone else for these services) of their services in your “Rental Income”;
- “Personal Use for Vacation” – there are limits (restrictions) on the total number of days each year in which you and your family or friends can use the properties and still meet the income producing property requirements;
- Depreciation – a determination has to be made regarding the fair market value of the dwelling and the land at the point in time you begin receiving rental or lease income. The dwelling itself is depreciated, but the land is not.
Seven Tips About Rental Income and ExpensesÂ
Do you rent property to others? If so, you’ll want to read the following seven tips from the IRS about rental income and expenses.
You generally must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use of or occupation of property. Expenses of renting property can be deducted from your gross rental income. You generally deduct your rental expenses in the year you pay them. Publication 527, Residential Rental Property, includes information on the expenses you can deduct if you rent property.
- When to report income. You generally must report rental income on your tax return in the year that you actually receive it.
- 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.
- 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.
- 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.
- Expenses paid by tenant. If your tenant pays any of your expenses, the payments are rental income. You must include them in your income. You can deduct the expenses if they are deductible rental expenses. See Rental Expenses in Publication 527, for more information.
- Rental expenses. Generally, the expenses of renting your property, such as maintenance, insurance, taxes, and interest, can be deducted from your rental income.
- 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.
For more information on rental income and expenses see Publication 527. This publication can be downloaded from http://www.irs.gov or ordered by calling 800-TAX-FORM (800-829-3676).
Links:
Publication 527, Residential Rental Property