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Rental Income and Taxes

If you receive rental income, you are required to report it to the IRS. Any income received from the use or occupation of your property is considered rental income. There are two methods of accounting: the cash method and the accrual method. If you use the cash method, you report your gross rental income on your return for the year in which you receive it (not when it was earned). If you use the accrual method, you report income when you earn it (and not when you receive it). Depending upon which accounting method you use, you may report your rental income accordingly.

What to Include in Rental Income

rental-incomeAlong with rental income, there are other amounts that are considered rental income and, therefore, must be reported on the return. These include:

  • Advance rent payments
  • Security deposit (if you retain a part or all of it)
  • Payment received for the cancellation of a lease

Advance rent payments that you receive in a particular year, regardless of the method of accounting, need to be included in your rental income. The amount is included in the year in which you receive it.

If you retain any part or the entire amount of the security deposit, it must be added to the rental income. Usually, the property owner returns the security deposit at the end of the lease. However, if the terms of the lease agreement are not fulfilled by the tenant, the owner may retain a part or all of the security deposit. In such a case, the amount is to be included in the rental income.

If the tenant pays you to cancel a lease, the payment for cancelation needs to be included in your rental income in the year in which you receive it, regardless of which method of accounting you use.

Tax Deductions for Owners of Rental Property

Any ordinary and necessary expenses made for the management and maintenance of the rental property are tax deductible. Usually, you can deduct expenses such as mortgage interest, property tax, operating expenses, depreciation, and repairs. Expenses paid by the tenant can also be deducted if they are ordinary and necessary expenses.

Improvements made in the rental property are deductible. These may include installing a new roof, fencing the area, adding a deck, etc. To report expenses on improvements, use Form 4562, Depreciation and Amortization. The cost of improvements is recovered through depreciation. Qualifying costs are deducted in the year in which they are incurred.

Reporting Renting Income

Use Form 1040, Schedule E, Part I if you rent out property, and provide only heat, light, and trash collection. List your total rental income, expenses, and depreciation for each rental property. If you rent out more than three properties, you need to attach Schedules E.