Things You Didn’t Know About Rental Real Estate Income
Having a spare property which you can give out on rent is a very good opportunity of earning additional income. In fact, for some, real estate forms a part of their only source of income.
Renting and leasing property brings in income and such income is, obviously, subject to taxation.
While you might know that your rental income is included in your taxable income and you pay tax on it, there are some aspects of this rental real estate income which might escape your attention. When it comes to filing your taxes correctly, any error might result in either high taxes or high penalties. Do you want to be a victim of either of these?
I hope your answer is a firm ‘No’ because mine definitely is. So, here are some facts which you might not have known about your rental real estate income:
Your accounting basis determines the inclusion of the rental income in your tax returns
There are two bases of accounting. One is the cash basis wherein transactions are accounted on the date when cash is received or paid for them irrespective of the actual date of such transactions. Other is the accrual basis where you record transactions on their actual date irrespective of when you receive/pay cash for them. For instance, for a transaction done in November where cash is received/paid in December, the cash basis would record the transaction in December while the accrual basis would record the transaction in November itself. In case of rental income too the same concept applies.
If you follow the cash basis of accounting, record your rental income in the tax return in the year you receive it.
For accrual basis, record it in the year for which the rent would accrue.
Tax treatment of advance rent and security deposits
Advance rents are always included in your return on the cash basis irrespective of the accounting basis you follow. In case of security deposits, there are two situations.
If you intend to use the entire security deposit as final rent payments, it becomes an advance rent.
In this case you should include it in the year when you receive the deposit. However, if you intend to return the security deposit at the end of the lease, do not include it in your tax return. If you ultimately return it there was no income on your part. But, if you use any part of the deposit or the total deposit for meeting the rent or any other payment from your tenant, you should include the money used in that year’s tax return.
Rental income can also be in kind
While most of us associate rental income to be in cash, your tenant might also render you some services or pay your rent in kind. Does this mean your income would not be taxed? Alas, no!
Rental income received in kind or by way of a service is also an income and is taxable.
To assess the absolute value of such income, use the Fair Market Value approach. The Fair Market Value of the service or the item received against rent payment would be your rental income for taxation purposes.
Using the property for both personal use and for renting
While you might usually rent out your property, at times, you might use it for personal use as well. In this case, the tax treatment of rental income would be different.
The periods for which the unit was used for personal use and for which it was rented would be used to determine whether or not the rental income would be chargeable to tax.
If, in a month, you used the property for personal use but rented it out for more than 15 days, the entire rental income should be included in your tax return. If, however, you rented it out for less than 15 days and also used the property for yourself, the rental income would not be taxable.
Did you know these facts? I bet you didn’t. Well, these are some common things which we don’t know about rental real estate income and so we err when filing our returns. So, understand these technicalities before you file your return so that the returns are filed correctly and you pay the correct tax due.