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Rental real estate tips, audit outlook

Is it just a coincidence that the IRS issued an information sheet about rental income and expenses just as the office that oversees the IRS put out a report saying some landlords were skating when it comes to taxes?

I don't think so.

Here's what probably prompted the IRS to try to educate landlords: An audit report from the Treasury Inspector General for Tax Administration (TIGTA) released to the public last week detailing the extent of tax reporting problems when it comes to rental property.

TIGTA's investigation, "Actions are Needed in the Identification, Selection, and Examination of Individual Tax Returns with Rental Real Estate Activity," was conducted because an earlier Government Accountability Office study found that in 2001 more than half of individual taxpayers with rental real estate misreported tax-related activity with regard to the properties.

Those rental property tax reporting mistakes resulted in an estimated $12.4 billion of net misreported income. That was a decade ago. God only knows how much more money the Treasury has lost since then in this area alone.

"Given the magnitude of underreporting in our voluntary system of tax compliance, even small improvements in the IRS's examination of tax returns with rental real estate activity could increase taxpayer compliance and generate substantial additional revenue to the Federal Government, helping reduce the Tax Gap," said J. Russell George, TIGTA's Inspector General, in a statement accompanying his office's report.

The IRS acknowledged that there is a problem in accurate rental real estate tax reporting, although the agency disputes the amount of tax money it cost. And the IRS agreed with TIGTA's recommendations on how to deal with the problem.

Essentially, the IRS is moving to better education rental propety owning taxpayers and, the stick side of this carrot, to eventually look more closely at such returns. The bottom line for rental owners is to report your activity and pay associated taxes or expect an eventual audit.

So that you don't end up facing an IRS examiner, the IRS offers seven tips about rental income and expenses:

  1. You generally must report rental income (any payment you receive for the use of or occupation of property) on your tax return in the year that you actually receive it.
  2. 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.
  3. 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 in that year.
  4. 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.
  5. 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.
  6. Generally, the expenses of renting your property, such as maintenance, insurance, taxes, and interest, can be deducted from your rental income.
  7. If you have any personal use of a vacation home or other dwelling unit that you rent out, you must divide your expenses between rental use and personal use.  If your expenses for rental use are more than your rental income, you may not be able to deduct all of the rental expenses.

You can get more information on rental income and expenses in IRS Publication 527, Residential Rental Property.

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Sally Johnson

Thanks for the informative information. I have been thinking of investing in real estate. I just want to make an informed decision.


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