Rental income includes any payment received for the use or
occupancy of property. In addition to normal rent payments, the following items
are reported as rental income.
Types of Rental
Income
Advance rent: Any
amount received prior to the period that the payment covers.
Payment for cancelling a lease: Any amount paid by a tenant to cancel a lease.
Expenses paid by tenant: Any
amount paid by a tenant on behalf of the landlord to cover maintenance or
improvement expenses.
Property or services: The
fair market value (FMV) of property or services received in lieu of rent.
All of these types of rent are reported as income in the
year received.
Security Deposits
A security deposit is not included in rental income when
received if the property owner plans to return it to the tenant at the end of
the lease. If any amount is kept during the year because the tenant did not
live up to the terms of the lease, include that amount as rental income. If an
amount called a security deposit is to be used as a final payment of rent, it
is advance rent and is included as income in the year received.
Note: Individual states have laws requiring payment of
interest by landlords who hold security deposits.
Rental Expenses
A deductible expense is any expense that is both:
• Ordinary.
Common and accepted in the taxpayer’s line of work, and
• Necessary.
Helpful and appropriate for work.
An expense need not be required in order to be considered
necessary. Facts and circumstances must be considered in each case to determine
whether an expense is ordinary and necessary.
Depreciation
Depreciation deductions begin when property is ready and
available for rent.
Vacant Property
Expenses are deductible beginning at the time the property
is available for rent regardless of when rental income is actually received.
Insurance Premiums
Paid in Advance
Insurance premiums paid more than 12 months in advance are
deducted in the year to which the policy applies. Premiums paid for 12 months
or less are deductible in the year paid.
Local Transportation
Expenses
Local transportation expenses incurred to collect rental
income or to manage, conserve, or maintain rental property are deductible. The
taxpayer may deduct either actual expenses or the standard mileage rate for an
auto (56.5¢ per mile for 2013).
Commuting
IRS regulations for investment expenses specifically mention
commuter’s expenses as being nondeductible, making the same commuting rules
that apply to business expenses also apply to passive rental activities.
Travel Expenses
Expenses for traveling away from home, such as
transportation and lodging, are deductible if the primary purpose of the trip
is to manage, collect rental income, conserve, or maintain the rental property.
Interest
Prepaid interest is not deducted when paid. Instead, prepaid
interest is deducted in the period to which it applies. Points or loan
origination fees paid for rental property are deducted over the life of the
loan.
Repairs and Improvements
Repairs Improvements
Costs that:
• Keep
the property in good operating condition,
• Do not
materially add value to the property, or
• Do not
substantially prolong the property’s life. Costs
that:
• Add to
the value of the property,
• Prolong
the property’s useful life, or
• Adapt
the property to new uses.
Examples:
• Repainting
inside or out.
• Fixing
gutters.
• Fixing
damaged carpet.
• Fixing
leaks.
• Plastering.
• Replacing
broken windows.
• Room
additions.
• Remodeling.
• Landscaping.
• New
roof.
• Security
system.
• Replacing
gravel driveway with concrete.
The cost of repairs to a rental property may be deducted as
a current expense. The cost of improvements must be recovered by taking
depreciation. Whether an expenditure qualifies as a currently deductible
repair, or is required to be capitalized, is a factual determination. The
taxpayer bears the burden of proof and must have sufficient records to
substantiate the expense as a deduction instead of a capital expenditure.
Personal Use of Rental Property—
Roommates and Boarders
Renting Part of Property
If a portion of property is rented out, and a portion is
used for personal purposes, any reasonable method of allocating expenses
between personal and rental use is allowed. For example, dividing the cost of
utilities by the number of people living in the home, or dividing expenses
based on square footage of use, are reasonable methods.
Phone Expense
The cost of the first phone line into a home that is used
for both personal and rental purposes is not deductible.
Direct Rental Expenses
A full deduction is allowed for expenses that belong only to
the rental part of the property. Examples of fully-deductible rental expenses
include painting a room that is rented out, additional liability insurance
attributable to the rental, and the cost of a second phone line that is
strictly for the tenant.
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