My daughter began renting her house in November of 2006. In addition to two months of rent, she received a deposit equal to a month's rent. How is this deposit handled?
Is a Schedule C the best way to handle the rent income?
Her gross rental proceeds include the deposit. The rental income and expenses are reported on Schedule E. For more information, see IRS Publication 527.
If she hasn't already, she should talk to a real estate lawyer to find out how it must be handled under local law. In some jurisdictions it must be held in an escrow account, with the interest paid annually to the tenant. For tax purposes it's nothing until she winds up using it, in which case it becomes rent received.
No. Rental income goes on Schedule E. See IRS Publication
527.-- Phil Marti Clarksburg, MD
I hope I cut and pasted correctly. I don't kow how leases are normally worded, but if the security deposit is to be returned (absent the tenant's failure on some part), then the security deposit is not included as income when it is received (i.e. when the lease begins). Do leases still call for "last month's rent" instead of a "security deposit". I suppose some do . . ..
Security deposits. Do not 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. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the part you keep in your income that year. If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Include it as income when you receive it.
Thanks Frederick, for this and other advice as well. One more quick question:
Am I correct that it's a toss-up as to whether my daughter depreciates the house she is now renting? Whatever she saves now would be lost later with recapture when she sells the house.
-- Ray
Thanks Herb --
Am I correct that claiming depreciation is a toss-up? Whatever my daughter saves now she would lose through recapture when she sells the house?
-- Ray
Do not 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. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year. If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Include it in your income when you receive it. Report rental income and expense on Schedule E.
Depreciation is definitely *not* a "toss-up." Claim it!! Here's why: she'll "lose through recapture" - that's your description - whatever she could save now, whether or not she chooses to save it now. "Depreciation - use it or lose it" is an apt but cynical description of how the IRS rules work.
I'd think it would be more in the nature of a loan than income.
That publication says,
"Do not 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. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year. "If an amount called a security deposit is to be used as a final payment of rent, it is advanced rent. Include it in your income when you receive it." Stu
I don't think so. If you don't take depreciation, and you are audited for the year in which you sell the property, I believe the depreciation will be imputed, and you will pay recapture taxes anyway. You may as well get the benefit of the depreciation and avoid the aggravation.
No, you are not correct. When she sells the property, her adjusted basis for calculating gain or loss is the cost less depreciation allowed OR ALLOWABLE. In other words, she must reduce her cost by the depreciation she should have claimed! AND, the unclaimed depreciation (allowable depreciation) is still subject to recapture. There are ways to minimize the effect of the reduction in basis for allowable but unclaimed depreciation. But, the recapture rule doesn't go away. Lanny K. Williams, CPA Nawarat, Williams & Co., Ltd. Income Tax Services for Expatriate Americans
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