Rent Deposit and Vacation Rental

Technical topics regarding tax preparation.
#1
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Have two situations involving vacation rental properties which are throwing me for a loop. In both situations, there is no requirement to repay any of the amount back to the lessee.

First is client with rent deposit of $10,000 in October 2017 for the rent of his personal condo during January through April of 2018. Since there is no requirement to repay, I believe the $10,000 should be included in income in 2017? Am I allowed any expenses (depreciation, property tax, etc) against the income in 2017, or is the property placed in service in 2018?

Almost the same situation with the second client. Once again, client gets $7,000 in October of 2017 for the rent of his personal condo, however, the dates of the rental are December 21, 2017 through February of 2018. I am now thinking that the rent for 2017 should be tax free as personal residence with limited rental use under 14 days. Do I prorate the rent by total rental days, and pick up only the 2018 portion of the rent as income? No depreciation until 2018 since no rental use in 2017?
 

#2
Nilodop  
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Both interesting. Reg. 1.61-8 is clear.
(b)Advance rentals; cancellation payments. Except as provided in section 467 and the regulations thereunder and except as otherwise provided by the Commissioner in published guidance (see § 601.601(d)(2) of this chapter), gross income includes advance rentals, which must be included in income for the year of receipt regardless of the period covered or the method of accounting employed by the taxpayer.
. I did not see any "otherwise provided" published guidance, but maybe there is some. And 467 is n/a.

RE: your first client, assuming there was no rental use in 2017, then I think he has the income and no offsetting deductions other than those that are allowed on Sch A for personal use property.

Re: your second client, there is arguably a conflict between the section 280A(g) rule,
... if a dwelling unit is used during the taxable year by the taxpayer as a residence and such dwelling unit is actually rented for less than 15 days during the taxable year, ...
, and the reg. cited above. What does the bold phrase mean? Does it refer to actual use by the lessee for less than 15 days in 2017? Or does it mean actually rented in 2017 (no issue there) in the aggregate for less than 15 days . The latter would be a problem but I think would be a very strained reading, i.e., I think you'd be OK on that point. And on how much rent to include, yes, I'd prorate, and include only the excess over 14 days as rent income. And on the depreciation question, only in 2018. Here is from a footnote in Norwest Corporation, 111 TC 105, a footnote that is only dictum in the case, but which I think is a correct interpretation. (sorry, I left out the footnote quote).
Consider that a lessor of income-producing property must take advance rentals into gross income in the year of receipt, sec. 1.61-8(b), Income Tax Regs., without any increased depreciation deduction in that year.


I guess another argument is that a subsequent law should trump an older reg.

Consider disclosure.

I am surprised that there have been no cases, Rev Ruls, or PLRs on situations like yours. Maybe I missed them.
Last edited by Nilodop on 11-Feb-2018 8:58pm, edited 1 time in total.
 

#3
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Since there is no requirement to repay, I believe the $10,000 should be included in income in 2017?


You have to be more clear. To the extent we have a damage/security deposit here, that part wouldn’t be taxable. Often, with a long-term residential rental, we collect the following up front: first month’s rent, last month’s rent and a damage/security deposit. The first two things are immediately taxable, but not the deposit. The deposit is not an “advance” rent payment. It would be sorted out later. You say there’s no requirement to repay, but I’m hard-pressed to believe your client didn’t secure a deposit, to some degree, from the tenant.
 

#4
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I think there's a whopper of an issue buried in here. Can a continuous twenty-eight day rental of a taxpayer's residence, fourteen days at the end of year one, and then another fourteen days at the beginning of year two, qualify for the 280A(g) exclusion in each of those two years?

Read the law, and then vote: yes or no...

U.S. Code § 280A(g) Special rule for certain rental use
Notwithstanding any other provision of this section or section 183, if a dwelling unit is used during the taxable year by the taxpayer as a residence and such dwelling unit is actually rented for less than 15 days during the taxable year, then—
(1) no deduction otherwise allowable under this chapter because of the rental use of such dwelling unit shall be allowed, and
(2) the income derived from such use for the taxable year shall not be included in the gross income of such taxpayer under section 61.
 

#5
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And we should also vote on whether the law should be written "less than 15 days" or "fewer than 15 days"...!! :o :o :o
 

#6
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Thanks for the responses. I agree Nilodop. I vote to exclude both years.
 

#7
Nilodop  
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Did I say that?
 

#8
gmhksgp  
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The question of whether the "rent deposit" is indeed income taxable at the time of receipt pursuant to §61 or a genuine deposit held in escrow and, therefore, not taxable should be examined based on all the facts, including terms of the rental agreement and your client's accounting treatment.

There have been numerous court cases since the days of old. In one of the more recent Supreme Court cases, Commissioner v. Indianapolis Power & Light Company, 493 U.S. 203 (1990), the Court delivered a ruling that is consistent with the long-held position of the Tax Court, quoting the following from the Tax Court opinion in J. & E. Enterprises Id., 26 TCM at 945-946:
If a sum is received by a lessor at the beginning of a lease, is subject to his unfettered control, and is to be applied as rent for a subsequent period during the term of the lease, such sum is income in the year of receipt even though in certain circumstances a refund thereof may be required. . . . If, on the other hand, a sum is deposited to secure the lessee's performance under a lease, and is to be returned at the expiration thereof, it is not taxable income even though the fund is deposited with the lessor instead of in escrow and the lessor has temporary use of the money. . . . In this situation, the acknowledged liability of the lessor to account for the deposited sum on the lessee's performance of the lease covenants prevents the sum from being taxable in the year of receipt.


The Court held that "although [the respondent] derives some economic benefit from the deposits, it does not have the requisite "complete dominion" over them at the time they are made, the crucial point for determining taxable income" and the deposit, therefore, should not constitute taxable income.

So long as it is evident from the rental agreement that the deposit is required to safeguard the lessee's performance (e.g. timely payment of future rental, reasonable upkeep of the property, etc.), which is outside the control of the lessor, it is to be returned to the lessee at the expiration, and that the lessor treats it as a liability in the accounting records, mere receipt of the deposit should not give rise to income.

As for the application of §280A in the second case, it would be reasonable to apply the statute in good faith based on a plain reading of the law in the absence of regulatory guidance and since no changes have been made by either the IRS or the legislators in spite of various reviews and proposals over the years.

If it is determined that the payment was an advanced rental payment, however, the entire amount, instead of a prorata amount, should generally be subject to tax in the year of receipt regardless of the taxpayer's method of accounting.
 

#9
Nilodop  
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If it is determined that the payment was an advanced rental payment, however, the entire amount, instead of a prorata amount, should generally be subject to tax in the year of receipt regardless of the taxpayer's method of accounting.. If you refer to the seond situation, why can they not get the 280A(g) treatment?
 

#10
gmhksgp  
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I was not presuming that they should not get the §280A(g) treatment. The last paragraph was meant to address both cases in the event WIBadgerCPA determines, based on the facts and circumstances, that the payment was not, in fact, a deposit but an advance rental payment.
 

#11
Nilodop  
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OK, then if it is advance rental, why can they not get the 280A(g) treatment?
 

#12
gmhksgp  
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I should have been clearer. The response was meant for case 1. As explained in my original message, "it would be reasonable to apply the statute in good faith based on a plain reading of the law" for case 2.
 


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