There are several scenarios and situations in which a taxpayer will purchase a dwelling (home, mobile home, condo, townhouse, etc) for the purpose of producing supplemental income and in some instances, concurrently providing a vacation home. These opportunities have become more prevalent in the past five years with the availability of “short” sales, bank foreclosures, declines in the market value of homes, the inability of many Americans to qualify for a mortgage for the purchase of a home (thereby being forced to rent), etc. Before you make an offer, start building, or applying for a loan, read IRS Publication 527  (“Residental Rental Property”)  before you sign on the dotted line.
If you meet all of the requirements, the income or loss from these activities will be reported on Schedule E (“Supplemental Income and Loss”) of your Federal Form 1040. There are many facts to be considered, including:
- “Advance Rent” payments from your tenants are included in the tax year in which you actually receive the money, and not the year or periods in which the payments cover;
- “Security Deposits”, which you receive from tenants to partially or fully cover your repair and cleaning costs after the tenants have vacated the premises may also have to be included as income, depending on the contract that you have with the tenants. These amounts are also a “liability” in your Balance Sheet accounts if there is a requirement for some or all of the funds to be returned to the tenant at the end of the rental or lease period; Â
- “Services in Lieu of Rent” If the tenants provide you with their services (cleaning your properties, handyman, plumbing, electrical, landscaping etc) then you’ll need to include the fair market value (what you would have actually had to pay someone else for these services) of their services in your “Rental Income”;
- “Personal Use for Vacation” – there are limits (restrictions) on the total number of days each year in which you and your family or friends can use the properties and still meet the income producing property requirements;
- Depreciation – a determination has to be made regarding the fair market value of the dwelling and the land at the point in time you begin receiving rental or lease income. The dwelling itself is depreciated, but the land is not. (more…)