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 It's important for landlords to report all taxable receipts in order to avoid underpayment tax penalties. At the same time, landlords should be aware of all deductible expenses so they don't overpay taxes. The IRS recently released a fact sheet listing various forms of rental real estate income and deductible rental expenses for landlords. The fact sheet is designed to reduce the tax gap by helping landlords better understand the tax code (FS-2007-21). Following are some of the highlights from this fact sheet.
Rental Income. Rental income is any payment received for the use or occupation of property. Other payments that landlords may need to report as income include:
- Advance rent payments.
- Early-termination fees on lease agreements.
- Expenses paid by a tenant on behalf of a landlord. These expenses may also be deductible as rental expenses.
- Any property or service that a landlord receives in lieu of money. The amount of income required to be reported is based on the fair market value of the property or services received by the landlord.
- Lease payments with an option to buy. If the tenant buys the property, payments received after the sale date are generally counted as part of the selling price.
Security deposits are not treated as income if they are to be refunded at the end of a lease period pursuant to an agreement. However, any funds withheld from a security deposit are treated as income in the year they are retained.
Rental Expenses. Landlords may deduct the ordinary and necessary expenses for managing, conserving and maintaining their rental property. Ordinary expenses are those that are common and generally accepted in the business, and necessary expenses are those that are deemed appropriate. Deductible expenses must be incurred from the time the property is made available for rent, and during the time the property is actually rented.
Other costs may include the following items:
- The cost of repairs is currently deductible, including the cost of labor and materials. However, landlords cannot deduct the value of their own labor.
- Improvements that add to the value of rental property or prolong its useful life may not be deducted as expenses. These improvements are considered capital expenses and must be depreciated.
If a landlord owns rental property that is also used for personal use, the expenses may be deducted on a proportional basis. Landlords are permitted to use any reasonable method for calculating what portion of a property should be considered rental. Using square footage is a common method and is frequently the most accurate.
Contact your Rea advisor if you have questions regarding the income and expenses pertaining to your rental properties.
-By Molly Farley, CPA (Wooster office)
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