 Income tax 2021-2022. Residential rental property, rental income, and expenses, if not personal use of dwelling. Part number one. Get ready to get refunds to the max diving in the income tax 2021-2022. Most of this information can be found in publication 527 Residential Rental Property Tax Year 2021 on the IRS website irs.gov irs.gov income tax formula focused on line one income. Although we would have a separate schedule basically being an income statement with income and expenses, expenses basically being deductions. The net then is what rolls in to line one income of the income tax formula as well as eventually page one of the form 1040. This is the schedule E the supplemental income and loss we're focusing in on the rental real estate. This is basically like the income statement. So this chapter discusses the various types of rental income and expenses for a residential rental activity with no personal use of the dwelling. So we're not talking about a split between personal and rental. We're talking full rental use in this section. Generally each year you will report all income and deduct all out of pocket expenses in full the deduction to recover the cost of your rental property depreciation depreciation being the rental property itself allocating the cost of that rental property over the life in essence depreciating it according to the tax code being a major component of the expenses. It's taken over the prescribed number of years and is discussed in chapter two. So we'll get to that later caution. If your rental income is from property you also use personally or rent to someone at less than a fair rental price first read chapter five. So we're talking full rental property here not property that's used for personal use. And if you were to rent the property to someone else like a family member of that of course complicates the situation as well because you don't have an arms length transaction. We can't really depend on the market to determine the market prices in that instance. So once again that complicates things a bit as opposed to a straight rental property where it's used 100% for rental property and you're renting it to someone who's not a family member. So rental income in most cases you must include in your gross income all amounts you receive as rent rental income is any payment you receive for the use or occupation of property. It isn't limited to amounts you receive as a normal rental payments. When to report? When you report rental income on your tax return generally depends on whether you are a cash or an accrual basis taxpayer. So we're getting back to those taxpayer terms. These are terms for business terms or accounting type of terms that we're going to put in play. Note that you've got the cash or accrual basis and then you've got kind of like the tax code which you got to follow of course they could then alter the basis that you're going to be on to some degree to be in compliance with it. So most individual taxpayers use the cash basis method. So when you're talking about individual taxes we're talking about basically a cash basis meaning you get the expenses usually when the cash goes out you record the revenue when the cash has been received for businesses then the larger the businesses the more likely you might be going from a cash basis to an accrual basis some standard types of business are kind of required to have an accrual basis because if you're using something like inventory or something like that those are types of things that often push businesses to need to use more of an accrual basis. Rental property obviously doesn't have the same kind of inventory component to it so that's not as much of a problem with the rental property. So a cash method what is it? You are a cash basis taxpayer if you report income on your return in the year you actually or constructively receive it regardless of when it was earned. So basically the idea there would be if you're talking about the revenue side of cash basis when you actually get the money or have constructively received and that is important then that's when you record the revenue. So basically if the rent was basically incurred say in December of the current year 2021 but it wasn't paid to you until January under a pure cash basis method you wouldn't record the income until January under an accrual method you would report it in December. Now note this could lead people to try to do tricky things then you might try to say well I can manipulate when I earn my revenue by altering when I'm gonna receive the cash and that can increase or decrease revenue in one period or another have a timing difference but you got to be careful on that because the IRS is one they could put in this constructively received so if you have actually control over the cash then you can't see you shouldn't you can't theoretically do that and to the IRS will probably then you know gonna put in limitations on how much you can kind of manipulate when income is reported based on just manipulating the cash flow. So you constructively receive income when it is a made available to you for example by being credited to your bank account. So accrual method on the other hand if you are an accrual based taxpayer you generally report income when you earn it rather when you receive it. So on an accrual basis if you rented the property in December someone used it in December but they didn't pay you till January on an accrual basis they used the property you earned the income you gave them the use of the property and it had been consumed in December therefore the income would be reported in December even though you didn't get the money until in that case January of the following year. You generally deduct your expenses when you incur them rather than when you pay them. So more information you can see publication 538 accounting periods and methods for more information about when to constructively receive income and accrual methods of accounting. So types of income the following are common types of rental income. We have the advanced rent so advanced rent is any amount you receive before the period that is covered so that's generally not you know how you well you might have an advanced payment basically when you start the rent but then typically you have the rental period and then they pay the rent so the rent advanced payment would mean you got the money before basically you did the work in this case providing the rental property. So what do you do with the advanced payment because now you got money but you haven't really you haven't really done the work for it so under an accrual basis method normally under accrual basis methods you would record the cash increase in the cash the other side wouldn't be income it would be going to a liability but often times the government or the IRS might deviate in some instances in advanced payment so include advanced rent and your rental income in the year you receive it regardless of the period covered or the method of accounting you use. So now note we looked at you can use the accrual method or you can use the cash method but under the tax code if you use the accrual method then if you get an advanced payment we want you to still use the cash method right because they don't want you to they want to record the money when you have when you have the money in that instance so they kind of breaking from the standard accrual method if you were on an accrual method. So example on March 18th 2021 you signed a 10-year lease to rent your property during 2021 you receive $9,600 for the first year's rent and $9,600 as rent for the last year of the lease so you got this $9,600 on the second amount that you that you haven't even provided the property yet for so it's an advanced payment which under accrual accounting would be a liability not income but you must include the $19,200 in rental income in 2021 so for taxes they're saying we want you to record that amount when you get it so you got some money like your silent partners like wait a second no you got to give us a piece our piece of that I don't care if you are on the accrual method is basically the idea so canceling a lease if your tenant pays you to cancel a lease the amount you receive is rent so if they pay you to cancel the lease then that you know that's going to be income include the payment in your rental income in the year you receive it regardless of your method of accounting expenses paid by the tenant if your tenant pays any of the expenses those payments are rental income because you must include this amount in income you can also deduct the expenses if they are deducted rental expenses for information you can see rental expenses later so in other words you might start to think well I have my tenant here and I've got like rental expenses maybe I'll have the tenant do you know do projects on the home or something like that and said of me doing those projects on the home well if that was the case then what you really have is you have a situation where they gave you you got income in that situation from them you know paying for the expenses and then you might be able to deduct the expenses so the bottom line might be the same because your income would go up and then and then you'd have the expenses but you would still generally have in that instance income and then and then basically the expenses so one more time so if you have expenses paid by the tenant the expenses were paid by the tenant if your tenant pays any of your expenses those payments are rental income so that so they paid it on your behalf it's basically income to you but because you must include this amount in income you can also deduct the expenses if they are deductible rental expenses so if they paid for expenses that are rental expenses then you could deduct them you can't do something like well what if they if the tenant paid for some personal stuff for me then I didn't actually get the cash they paid for my personal subscription to something or something like that well then it would still be income to you and you couldn't deduct it in that case because they paid for something that wasn't actually rental expenses you can't just say one I didn't that's kind of like bartering or trading I gave you property and you buy and you don't pay for some some thing that I get right and that's it's still income in that instance is the general idea so example one you're this would be good have some examples your tenant pays the water and sewage bill for your rental property and deducts the amount from the normal rent payment under that so now they paid for the bill and they deducted that from the rental payment so does that mean you didn't really get that rent no they just paid the rent on your behalf by paying an expense that you would otherwise have had to pay so under the terms of the lease your tenant doesn't have to pay this bill so they didn't they weren't responsible for that bill under the terms of the lease they pay you are as the as so they paid our bill so include the utility bill paid by the tenant and any amount received as rent payment in your rental income so we still have to include it in income you can deduct the utility payment made by your tenant as as a rental expense so we can't avoid the rental income by having the tenant pay our expense but we would have them included in the rental income and then we might get the deduction if it was something that was a deductible expense example two what you are out of town the furnace in your rental property stops working your tenant pays for the necessary repairs and deducts the repair bill from the rent payment include the repair bill paid by the tenant and any amount received as rent payment in the rental income but then you can deduct the repair payment made by your tenant as the rental expense property or services if you receive property or services as rent instead of money include the fair market value of the property or services in your rental income so if you were to say okay you know we've got the rent here but I accept you know a painting or something from you or something like that in exchange for the rent that doesn't mean that you didn't get any income that just means you got paid in some other means other than dollars and therefore you still have to record the income so if the services are provided at an agreed upon or specified price that price is the fair market value unless there is evidence to the contrary example your tenant is a house painter he offers to paint your rental property instead of paying two months of rent you accept the offer so he's going to paint the property that means you basically bartered for the use of the property and then he's going to paint the property you get you give him the use of the property that means that you still have to record the income including the rental income the amount the tenant would have paid for two months of rent you can deduct that same amount as rental expense for the painting of the property so again if the thing that they gave you was for the rental property like the painting of the rental property then you can deduct it but if it if they gave you something that was personal like tickets to a game or something like that then you know that wouldn't be that wouldn't be deductible but you still have to include the income security deposit don't include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease so notice this is a little bit different than the the prepayment we saw before if they had a prepayment for a last month's rent or something like that on the lease then we might have to include the prepayment when we receive it our security deposit in theory we all know it's just a lie but in theory you're supposed to give the security deposit back if the property was like in good condition right that's the security deposit so in that case you got the money but you're you're planning on not just giving them the use of the property to earn the money later in accordance with a lease that already has been put down but you're you're planning on giving them the security deposit back if certain conditions are met and therefore you wouldn't include it in income at the point in time that you receive the security deposit it should basically be a liability you're holding on to it and just to make sure like don't mess up my property or I'm gonna take your security deposit is the kind of thing but if you keep part or all of the security deposit during any year because your tenant doesn't live up to the lease terms I include the amount you keep in your income so when the tenant destroys your property then you're like all right that's it now I keep the security deposit well now it's income of course because you don't have to give it back at that point and therefore it's got to be included and the IRS wants their share their cut so you got to include an taxable income if an amount called security deposit is to be used as a final payment of rent it is advanced payment included in your income when you receive it so see the difference in categorization if it's just an advanced payment and you're not going to give it back according to the lease they're locked into the lease they have to be there for that last month and you're not giving back the payment even though they haven't yet used the property under a cruel accounting it would still be unearned revenue but the IRS wants their money in that case but if it was a security deposit which in theory they would get back at the end it's not a it's not a foregoing conclusion according to the terms of the lease that you're not giving back the security deposit even though we all know that we're totally holding on to but it's not a foregoing conclusion so then it would be not included in income until the point in time when you say no I'm holding on to that security deposit and then it would be income so difference happening