Rental Income Definition
You generally must include in your gross income all amounts you received as rent. Rental income is any payment you receive for the use or occupancy of property. You must also report income that you “constructively” receive. Constructive receipt of income means that you have the opportunity to receive the income.
Rental income example: If you rent a house and the tenant pays you for their January rent with a check in late December, you cannot avoid reporting it as rental income by not depositing it in your bank until January.
As mentioned earlier, rental income is defined as any payment you receive for the use of property. There are other types of “income” related to the renting of your property. These include:
Advance rent is any amount you receive before the period that it covers. You need to include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting used.
Rental income advance rent example 1: Mark signs a 10 year lease to rent his property. In the first year he receives $5,000 for the first year’s rent and $5,000 as rent for the last year of the lease. Mark must include $10,000 in his income for the year.
Rental income advance rent example 2: Mark rents a room to Lori. He receives a rent check in December 2013 from Lori for her January 2014 rent. Mark must report the rent as income on his 2013 tax return.
You do not need to 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. If you keep part of the security deposit during any year because your tenant doesn’t live up to the terms of the lease, you will need to include the amount 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. You will need to include it in your income when you receive it.
Payment for canceling a lease
If your tenant pays you to cancel a lease, the amount you receive is rent. You will need to include the payment in your income in the year you receive it.
Expense paid by tenant
If your tenant pays any of your expenses, the payments are rental income. You must include them in your income. You can deduct expenses if they are deductible rental expenses.
If your tenant pays your utility bills or your emergency repairs and deducts the amount from the rent payment, you must include as rental income the full rental amount, not the actual net payment. You can claim an offsetting deduction for expenses, such as repairs, that would have been deductible had you paid them.
Rental income expenses paid by tenant example 1: Lance rents out a house to Sean. While Lance is vacationing in France the furnace stops working in his rental property. Sean pays for the necessary repairs and deducts the repair bill from his rent payment. Lance will need to include the rent payment received from Sean and the amount Sean paid for the repair in his rental income. Lance doesn’t have to worry though because he will be able to deduct the cost of the repair as a rental expense.
Rental income expenses paid by tenant example 2: Chuck rents a house from Nathan. He pays the water and sewage bill for Nathan’s rental property and deducts it from the normal rent payment. Under the terms of the lease, Chuck does not have to pay the water and sewage bill. Nathan will need to include the utility bill paid by Chuck and any amount received as a rent payment in his rental income. Nathan can deduce the utility payment made by Chuck as a rental expense.
Property or services
If you receive property or services instead of money as rent, you will need to include the fair market value of the property or services in your rental income. If you agree upon a specified price for services rendered, that price is the fair market value unless there is evidence to the contrary.
Rental income example: Jody rents out a condo to Nick. Nick is a painter and offers to paint the condo instead of paying 2 months rent. Jody decides to accept the offer and must include in her rental income the amount that Nick would have paid for 2 months rent. Jody can also deduct that same amount as a rental expense for painting the property.
Lease with option to buy
If the rental agreement gives the tenant the right to buy your rental property, the payments you receive under the agreement are considered rental income. If your tenant exercises the right to buy the property, the payments you receive for the period after the date of sale are considered part of the selling price.
Rental of property also used as a home
If you rent property that you use as your home and you rent it fewer than 15 days during the tax year, you don’t need to include the rent you receive in your income and you don’t have to deduct rental expenses either.
If you own a part interest in rental property, you must report your part of the rental income from the property.
Insurance proceeds for loss of rental income because of fire or other casualty are treated as rental income.
When to Report Rental Income
If you are a cash based taxpayer, which you will more than likely be, you are required by the IRS to report rental income on your return for the year you actually or constructively receive it. If you use an accrual method, you report income on your tax return for the year in which you are entitled to receive payment, even if it’s not actually paid. An example would be a business that sells a computer on December 29, 2013 and bills the customer the first week of January 2014, and ultimately receives payment the next month. Under the accrual basis, the business would report the amount received in it’s 2013 income. Accounting methods are outside the scope of this website so if you would like to learn more you can read IRS publication 538, Accounting Periods and Methods.