Reporting Rental Income and Expenses

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Reporting Rental Income

You must report rental income on your tax return for the year you actually or constructively receive it. You constructively receive income when it is made available to you, for example, by being credited to your bank account. Any income you receive from the rental of residential or nonresidential real estate is rental income, and must be included in your gross income.

In addition to the actual rental payments you receive, the following must also be included in rental income:

Advance rent
You must include advance rent in your rental income in the year you receive it, regardless of the period covered, or the method of accounting you use. Advance rent is any amount you receive before the period that it covers.

Cancellation of lease payments
If a tenant pays you to cancel a lease, this money is also considered rental income, and must be reported in the year you receive it.

Expenses paid by tenants
You must include income, any expenses paid by a tenant and deducted from subsequent rental payments. If your tenant pays any of your expenses in lieu of rent, the payments are regarded as rental income. For example, if your tenant pays the water and sewage bill for your rental property and deducts it from the normal rent payment,you must treat the amount of the expenses paid by your tenant as rental income, but you can deduct them if they qualify as deductible rental expenses.

Property and services in lieu of rent
If you receive property or services, instead of money, as rent, you must include the fair market value of the property or services received 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. For example, your tenant offers to do repairs to your rental property instead of paying 2 months’ rent; you must include in your rental income the amount the tenant would have paid for 2 months’ rent. You can include that same amount as a rental expense for repairs to your property.

Security deposits
You must include income, any security deposit that is not returned to a tenant, and any security deposit intended to be utilized as the last month’s rent. Do not include a security deposit in your income 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, you must include the amount that you keep, in your income for that year.If an amount called a security deposit is to be used as a final payment of rent, it is actually advance rent, and must be included in your income when you receive it.

Real Estate Rental Expenses

Expenses of rental property can be deducted from gross rental income. You generally deduct your rental expenses in the year you pay them.Below are some of the main expenses that are usually associated with rental real estate property.

Repairs
You can deduct the cost of repairs that you make to your rental property. However, you may not deduct the cost of improvements; this cost is recovered through depreciation (see below). The distinction between repairs and improvements is as follows:

(a) A repair keeps your property in good operating condition and does not materially add value to the property. Some examples of repairs are: painting, fixing leaks and cracks, and replacing broken doors or windows.
(b) An improvement adds to the value of your property, prolongs its useful life, or adapts it to new uses. Examples of improvements are: adding a room, a deck, a fence, or a new roof.

Auto and travel expenses
You can also deduct your related auto and travel expenses, if the main purpose of the travel is to collect rental income, or to manage or maintain the rental property.
If you travel away from your home, you can deduct 50% of the cost of your meals.
If you use your personal vehicle for rental related purposes, you can deduct the expense using either the standard mileage rate, or the actual expenses incurred.
You must keep written records of all your travel expenses, and must be able to allocate expenses between rental and non-rental activities.

Depreciation
Depreciation is a deduction that many people earning real estate rental income often overlook on their tax returns. You are entitled to deduct an amount for depreciation of your property (see chapter 12). This is a yearly deduction for some or all of what you paid for your property, which reduces your taxable rental income. Residential rental property is depreciation over 27 ½ years, and nonresidential rental property is depreciated over 31 ½ years if placed in service before 5/13/1993, and over 39 years if placed in service after 5/12/1993. You do not include the value of land in the value of your property for depreciation purposes; land is never depreciated.


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