With very few exceptions, all income earned by American taxpayers – both individuals and entities – is taxable in one way or another. This, not surprisingly, includes income earned by renting property. Whether this income is payable by the individual or an entity depends on who the legal owner of the property is, but the income remains taxable. In fact, people failing to report, or under-reporting rental income is a major source of the “tax gap”, the difference between the amount owed each year and the amount collected each year by the Internal Revenue Service (IRS). This means that owners of rental property face additional scrutiny in the audit process, so the owners or beneficiaries of rental property should be sure to keep proper records.
Generally speaking, rental income includes any and all monies received in exchange for the use or occupation of property, and though this most commonly refers to real estate, it may also apply to other rental properties like storage units or household items (like renting household appliances). Most landlords operate their rental properties on a cash basis, which means that both the amounts received and the relevant deductions are claimed for the specific period of time in which these amounts were received or spent. This makes the reporting of rental income much easier than the alternative models, however it also leads many people to under-report since they do not consider all income received as rental income, though the IRS does.
The basic rent amount is self-evidently something that has to be reported as rental income, but there are also a myriad of other amounts on money received that also count as rental income and must be reported as such. These include, but are not limited to: (a) rent payments made in advance; (b) fees charged for the early termination of a lease; (c) some expenses paid by the tenant for the landlord; (d) property or services received in place of money; and others. Further, there are special provisions for rent-to-own payments and other arrangements related to rental agreements.
Security deposits are not usually considered income and should not be reported as such upon initial receipt. However, if the land lord opts to retain all or part of the security deposit once the initial agreement is concluded because the tenant did not live up to his obligations; this retained portion of the security deposit becomes income and has to be reported as such. This is one of the most common mistakes made by landlords and one that RS auditors are careful to look for when examining a landlord’s records.
Offsetting this reportable income is also a wide range of deductions that can be claimed as expenses by the landlord. These can range from major devaluations through depreciation to minor deductions such as the purchasing of materials for maintenance of the rental property. The overall tax ramifications of owning and renting property can be complicated, so it is frequently in the landlord’s best interest to hire a tax professional to help them determine what has to be reported and what deductions can be claimed.
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