Zoe Alvarez
If you own rental real estate, you must report your rental income on your tax return. This includes cash payments, the fair market value of property or services you receive, advance rent, security deposits used as final rent payments, and expenses paid by the tenant. You can deduct rental expenses, such as mortgage interest, property tax, repairs, and maintenance, from your rental income. However, if you are just a tenant renting a property for personal use, you generally cannot deduct rent payments on your federal income tax return. There are exceptions for independent business owners and rental property owners in certain states, and you may be able to claim a Renter's Credit.
| Characteristics | Values |
|---|---|
| Rental income | Must be reported on your tax return |
| Rental expenses | Can be deducted from your rental income |
| Cash basis taxpayer | Report rental income for the year you receive it, regardless of when it was earned |
| Accrual method | Report income when you earn it, deduct expenses when you incur them |
| Advance rent | Include in rental income for the year you receive it |
| Security deposits | Include in income if used as final rent payment or kept due to tenant breaking lease |
| Expenses paid by tenant | Include in income, can deduct if they are deductible rental expenses |
| Amounts paid to cancel a lease | Include in rental income for the year you receive it |
| Independent business owners | May be able to deduct a portion of rent |
| State-specific circumstances | Some states offer a Renter's Credit with potential tax benefits |
| Non-compliance | Possible consequences include back taxes, fines, penalties, and criminal charges |
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What You'll Learn
Rental income must be reported
If you own rental real estate, you must be aware of your federal tax responsibilities. All rental income must be reported on your tax return. This includes any payment you receive for the use or occupation of your property. Generally, you can deduct expenses from renting out the property from your rental income.
Rental income includes any amounts received as normal rent payments, as well as other amounts that may be classified as rental income. For instance, advance rent, which is any amount received before the period it covers, must be included in your rental income for the year you receive it, regardless of the accounting method used. Security deposits used as final rent payments are also considered advance rent and must be included in your income when received. If your tenant pays any of your expenses, these payments are rental income and must be included in your income, but you can deduct them if they are considered deductible rental expenses. Amounts paid to cancel a lease are also rental income and must be reported in the year they are received.
If you receive property or services instead of money as rent, you must include the fair market value of the property or services in your rental income. For example, if your tenant offers to paint your rental property instead of paying two months' rent, you must include the amount the tenant would have paid for two months' rent in your rental income.
It is important to maintain good records of your rental activities, including rental income and expenses. Proper documentation will help you monitor the progress of your rental property, prepare financial statements, identify the source of receipts, keep track of deductible expenses, and support items reported on tax returns. If you are audited and cannot provide evidence for items reported on your tax returns, you may be subject to additional taxes and penalties.
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Deducting expenses
If you own rental property, you must report all rental income on your tax return. In general, you can deduct expenses from renting property from your rental income. These expenses may include mortgage interest, property tax, operating expenses, depreciation, repairs, and maintenance.
As a cash basis taxpayer, you report rental income on your return for the year you receive it, regardless of when it was earned. You deduct your rental expenses in the year you pay them. If you use an accrual method, you report income when you earn it and deduct expenses when you incur them, not when you pay them. Most individuals use the cash method of accounting.
You can deduct the ordinary and necessary expenses for managing, conserving, and maintaining your rental property. Ordinary expenses are those that are common and generally accepted in the business, such as interest, taxes, advertising, utilities, and insurance. Necessary expenses are those that are deemed appropriate, such as maintenance. You can deduct the costs of certain materials, supplies, repairs, and maintenance to keep your property in good operating condition.
You can also deduct expenses paid by the tenant if they are deductible rental expenses. For example, if your tenant pays for repairs to your rental property, you can deduct the cost of those repairs from your rental income. If your tenant pays any expenses that are not deductible, such as personal expenses, you must still include those payments in your rental income.
It's important to maintain good records of your rental income and expenses. In the case of an audit, you must be able to provide documentary evidence, such as receipts, canceled checks, or bills, to support your expenses.
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Security deposits
If you are a landlord, you must declare security deposits as income on your tax return if you keep part or all of the deposit during any year. This could be because your tenant has not lived up to the terms of the lease, such as missing rent payments or causing damage to the property. Security deposits used as a final payment of rent are considered advance rent and should be included in your income when you receive it.
However, if you receive a security deposit with the intention of returning it to your tenant at the end of their lease, it is not considered rental income and does not need to be reported as income. Security deposits are typically not considered income because they are meant to be returned to tenants.
If you are a tenant, getting your security deposit back is generally not considered income, unless you receive more than the original amount. For example, if you receive double the deposit as compensation for not receiving it back in time, the excess amount may be considered taxable income.
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Cash basis taxpayers
If you are a cash basis taxpayer, you report your rental income on your tax return for the year you receive it, regardless of when it was earned. This means that you count your rental income as income when you receive it and deduct your expenses when you pay them. Most individuals use the cash basis method, which is also referred to as the cash method of accounting.
As a cash basis taxpayer, you can deduct expenses from your rental income. These expenses may include mortgage interest, property tax, operating expenses, depreciation, repairs, and maintenance. You can also deduct the expenses paid by the tenant if they are deductible rental expenses. However, you cannot deduct money spent on improving, renovating, or remodelling your property.
When reporting your rental income, you can use Schedule E (Form 1040), Supplemental Income and Loss, to report income and expenses related to real estate rentals. If you are not in the business of renting personal property, report your income on line 81 and expenses on line 24b of Schedule 1 (Form 1040), Additional Income and Adjustments to Income.
It is important to note that if you receive advance rent, which is any amount received before the period it covers, you must include it in your rental income for the year you receive it, regardless of the accounting method you use. Similarly, if you receive a security deposit as a final rent payment or deduct part of it due to damage by the tenant, it is considered rental income. However, if you intend to return the security deposit at the end of the lease, do not include it as income.
As a cash basis taxpayer, if you have uncollected rent, do not deduct it because you haven't included it in your income. If you use an accrual method, you can report uncollected rent as income when it is earned, and it may be deductible as a business bad debt.
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Record-keeping
Rental Income and Expenses
Keep detailed records of rental income and expenses for each property separately. This includes normal rent payments, advance rent (received before the covered period), security deposits used as final rent payments, and expenses paid by tenants. Report rental income on your tax return for the year you receive it, and deduct eligible expenses from your rental income.
Documentation and Receipts
Maintain documentary evidence, such as receipts, credit card records, cancelled checks, and bills, to support your expenses. This is crucial if your return is selected for an audit by the IRS. Certain expenses, such as travel and entertainment, require stringent documentation.
Employee Records
If your rental business has employees, maintain employee files, including payroll tax records, withholding records, and employment tax returns. Keep these records for at least four years per IRS guidelines, but check with your state employment agency as state requirements may differ.
Policy and Procedure Documents
Keep policy and procedure documents related to your properties, such as insurance policies and homeowners' association covenants. Store these documents for as long as you own the property plus three years.
Record Retention
Financial experts recommend retaining records for seven years after selling a property, but check with your state tax agency as guidelines vary. Keep mortgage payoff notices indefinitely, and save documents related to specific transactions, such as section 1031 exchanges, for as long as you own the new property plus three years.
Tenant-Related Records
Maintain records regarding tenants and applicants to resolve disputes or civil litigation. Keep tenant records even after they move out, as they may have several years to file a civil suit.
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Frequently asked questions
Yes, rental income is typically taxable and must be reported on your tax return. This includes any payment received for the use or occupation of property, including advance rent and security deposits used as final rent payments.
Rental income includes the total amount received as normal rent payments, as well as any property or services received instead of monetary payments. For example, if a tenant is a painter and offers to paint your rental property instead of paying rent for two months, the fair market value of this service must be included in your rental income.
Yes, you can generally deduct expenses related to renting out a property from your rental income. These expenses may include mortgage interest, property tax, operating expenses, repairs, and depreciation. Keep good records of your rental activities and expenses to substantiate your deductions if audited by the IRS.
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