Anytime someone else pays you to use or occupy your property, that's rental income. And yes, we mean anytime. Unless you rent your property for less than 15 days in a given year, you'll need to include all of the following forms of passive rental income in your gross income and report it on IRS Form 1040 Schedule E to avoid running afoul of Uncle Sam.
Source: Getty Images
1. Advance rent
Even if your tenant gives you an advance rent payment for a subsequent year, you must include it in your gross income in the year you receive it.
Let's say you're charging $350 a month to rent out your guest bedroom. In January 2021, your tenant paid you $8,400 -- two years' rent in advance. Even though half that money's paying for a future year's rent, you'd need to include the entire $8,400 payment in your gross income for 2021.
2. Service in lieu of rent
If you receive services, instead of money, as rent, you should include their fair market value in your rental income. For example, if your tenant is a plumber and makes repairs to the guest room's bathroom sink, you can both agree that you'll accept the value of the service in exchange for rent. You'll need to research local plumbers to see what they'd charge for such a service, and then include that amount in your gross income.
3. Property in lieu of rent
Sometimes a renter may offer you property in place of cash payments. If you accept this form of payment, you will need to include the fair market value of the property in your gross income.
4. Expenses paid by tenant
If your tenant pays any of your expenses for the repair or maintenance of the room or property, you'll either need to fully reimburse them for those costs, or include the payment for the expense in your gross income. Here are a couple of examples to help you know what does and doesn't count:
Suppose that while you're out of town, your tenant notices that the ceiling in their room is leaking. Instead of waiting for you to return, your tenant calls a plumber and pays out of pocket for the repair. Since the tenant paid for a repair on a property that you own, the value was conferred to you and you must include the cost as part of your rental income.
But what if, while you were on that trip out of town, the sink in your tenant's bathroom clogged? Again, your tenant doesn't wait -- they hire a plumber from a listing on Craigslist and have the sink repaired for $100. When you get back and learn about the repairs, you reimburse the tenant for that $100 cost. Since you paid the tenant back, you won't have to include the value of the expense as part of your rental income.
5. Security deposit
Requesting a security deposit is a pretty standard practice in the real estate industry, but IRS regulations oblige you to handle them with care.
If you receive a security deposit and retain it, or if it's paid in advance as a final rent payment, then the payments should also be included in your gross income.
If you keep part or all of your security deposit because the tenant damages your property and you must make repairs, the portion of the security deposit used should be included in your gross income, if your accounting practice is to deduct the cost of repairs as an expense. If however, the security deposit is used to reimburse you for the expenses paid, you should not include this amount as part of your income.
On the other hand, if you don't keep your tenants' security deposit, and you're required to return it at the end of the lease term, your gross income doesn't need to include that amount.
Avoid an IRS nightmare
Leaving out any of these payments, intentionally or otherwise, can cost you. If the IRS decides you made a careless mistake, they'll tack on a 20% penalty to the amount you underpaid -- on top of the original taxes you owe. But if they find you left out income on purpose, the IRS can charge you 75% of the taxes owed. Knowing what is included as part of your rental income will help to ensure that you report it honestly, and stay in Uncle Sam's good graces.
