Rental Income and Expenses
Important Change
Special depreciation allowance.
You can claim a special depreciation allowance for qualified property you placed in service after September 10, 2001. The allowance is a
depreciation deduction equal to 30% of the property's depreciable basis.
Qualified property includes property depreciated under the modified accelerated cost recovery system (MACRS) with a recovery period of 20
years or less. See Special Depreciation Allowance under Depreciation later, for more information.
Introduction
This chapter discusses rental income and expenses. It covers the following topics.
- Rental income.
- Rental expenses.
- Personal use of dwelling unit (including vacation home).
- Depreciation.
- Limits on rental losses.
- How to report your rental income and expenses.
If you sell or otherwise dispose of your rental property, see Publication 544, Sales and Other Dispositions of Assets.
If you have a loss from damage to, or theft of, rental property, see Publication 547, Casualties, Disasters, and Thefts.
If you rent a condominium or a cooperative apartment, some special rules apply to you even though you receive the same tax treatment as other
owners of rental property. See Publication 527, Residential Rental Property, for more information.
Useful Items You may want to see:
Publication
- 527
Residential Rental Property
- 534
Depreciating Property Placed in Service Before 1987
- 535
Business Expenses
- 925
Passive Activity and At-Risk Rules
- 946
How To Depreciate Property
Form (and Instructions)
- 4562
Depreciation and Amortization
- 6251
Alternative Minimum Tax - Individuals
- 8582
Passive Activity Loss Limitations
- Schedule E (Form 1040)
Supplemental Income and Loss
Rental Income
You generally 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. In addition to amounts you receive as normal rent payments, there are other amounts that may be rental income.
When to report.
Report rental income on your return for the year you actually or constructively receive it, if you are a cash basis taxpayer. You are a cash basis
taxpayer if you report income in the year you receive it, regardless of when it was earned. You constructively receive income when it is made
available to you, for example, by being credited to your bank account.
For more information about when you constructively receive income, see Accounting Methods in chapter 1.
Advance rent.
Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it
regardless of the period covered or the method of accounting you use.
Example.
You sign a 10-year lease to rent your property. In the first year, you receive $5,000 for the first year's rent and $5,000 as rent for the last
year of the lease. You must include $10,000 in your income in the first year.
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 amount you keep
in your income for 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.
Payment for canceling a lease.
If your tenant pays you to cancel a lease, the amount you receive is rent. Include the payment in your income in the year you receive it regardless
of your method of accounting.
Expenses 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 the expenses if they
are deductible rental expenses. See Rental Expenses, later, for more information.
Property or services.
If you receive property or services, instead of money, as rent, include the fair market value of the property or services in your rental income.
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.
Rental of property also used as a home.
If you rent property that you also use as your home and you rent it fewer than 15 days during the tax year, do not include the rent you receive in
your income and do not deduct rental expenses. However, you can deduct on Schedule A (Form 1040) the interest, taxes, and casualty and theft losses
that are allowed for nonrental property. See Personal Use of Dwelling Unit (Including Vacation Home), later.
Part interest.
If you own a part interest in rental property, you must report your part of the rental income from the property.
Rental Expenses
This part discusses repairs and certain other expenses of renting property that you ordinarily can deduct from your rental income. It includes
information on the expenses you can deduct if you rent part of your property, or if you change your property to rental use. Depreciation, which you
can also deduct from your rental income, is discussed later.
When to deduct.
You generally deduct your rental expenses in the year you pay them.
Vacant rental property.
If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing,
conserving, or maintaining the property while the property is vacant. However, you cannot deduct any loss of rental income for the period the property
is vacant.
Pre-rental expenses.
You can deduct your ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available
for rent.
Depreciation.
You can begin to depreciate rental property when it is ready and available for rent. See Placed-in Service Date under Depreciation,
later.
Expenses for rental property sold.
If you sell property you held for rental purposes, you can deduct the ordinary and necessary expenses for managing, conserving, or maintaining the
property until it is sold.
Personal use of rental property.
If you sometimes use your rental property for personal purposes, you must divide your expenses between rental and personal use. Also, your rental
expense deductions may be limited. See Personal Use of Dwelling Unit (Including Vacation Home), later.
Part interest.
If you own a part interest in rental property, you can deduct your part of the expenses that you paid.
Repairs and Improvements
You can deduct the cost of repairs to your rental property. You cannot deduct the cost of improvements. You recover the cost of improvements by
taking depreciation (explained later).
Separate the costs of repairs and improvements, and keep accurate records. You will need to know the cost of improvements when you sell or
depreciate your property.
Repairs.
A repair keeps your property in good operating condition. It does not materially add to the value of your property or substantially prolong its
life. Repainting your property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of
repairs.
If you make repairs as part of an extensive remodeling or restoration of your property, the whole job is an improvement.
Improvements.
An improvement adds to the value of your property, prolongs its useful life, or adapts it to new uses. Improvements include the following items.
- Putting a recreation room in an unfinished basement.
- Paneling a den.
- Adding a bathroom or bedroom.
- Putting decorative grillwork on a balcony.
- Putting up a fence.
- Putting in new plumbing or wiring.
- Putting in new cabinets.
- Putting on a new roof.
- Paving a driveway.
If you make an improvement to property, the cost of the improvement must be capitalized. The capitalized cost can generally be depreciated as if
the improvement were separate property.
Other Expenses
Other expenses you can deduct from your rental income include advertising, cleaning and maintenance services, utilities, fire and liability
insurance, taxes, interest, commissions for the collection of rent, ordinary and necessary travel and transportation, and other expenses, discussed
next.
Rental payments for property.
You can deduct the rent you pay for property that you use for rental purposes. If you buy a leasehold for rental purposes, you can deduct an equal
part of the cost each year over the term of the lease.
Rental of equipment.
You can deduct the rent you pay for equipment that you use for rental purposes. However, in some cases, lease contracts are actually purchase
contracts. If so, you cannot deduct these payments. You can recover the cost of purchased equipment through depreciation.
Insurance premiums paid in advance.
If you pay an insurance premium for more than one year in advance, each year you can deduct the part of the premium payment that will apply to that
year. You cannot deduct the total premium in the year you pay it.
Local benefit taxes.
Generally, you cannot deduct charges for local benefits that increase the value of your property, such as charges for putting in streets,
sidewalks, or water and sewer systems. These charges are nondepreciable capital expenditures. You must add them to the basis of your property. You can
deduct local benefit taxes if they are for maintaining, repairing, or paying interest charges for the benefits.
Travel expenses.
You can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip was to collect rental income or
to manage, conserve, or maintain your rental property. You must properly allocate your expenses between rental and nonrental activities. For
information on travel expenses, see chapter 28.
To deduct travel expenses, you must keep records that follow the rules in chapter 28.
Local transportation expenses.
You can deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or
maintain your rental property.
Generally, if you use your personal car, pickup truck, or light van for rental activities, you can deduct the expenses using one of two methods:
actual expenses or the standard mileage rate. For 2002, the standard mileage rate for all business miles is 36½ cents a mile. For more
information, see chapter 28.
To deduct car expenses under either method, you must keep records that follow the rules in chapter 28. In addition, you must complete Part V of
Form 4562 and attach it to your tax return.
Tax return preparation.
You can deduct, as a rental expense, the part of the tax return preparation fees you paid to prepare Part I of Schedule E (Form 1040). You can also
deduct, as a rental expense, any portion of the total expense you paid to resolve a tax underpayment related to your rental activities. On your 2002
Schedule E, you can deduct fees paid in 2002 to prepare Part I of your 2001 Schedule E.
