If you’re a landlord who has tenants who aren’t paying, you may be wondering if you can deduct unpaid rent. It depends on how you keep your books and usually recognize rental income.
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This post is provided for general information only. Please confirm the details and circumstances of your unique situation with your tax accountant or other appropriate advisor before taking action.
Can you deduct unpaid rent if you use cash-basis accounting?
Most landlords use the cash method of accounting. This means you enter things in your books when you get the cash. For example, if you got your January 1, 2022 rent on December 31, 2021, you enter it in your 2021 income.
You can’t claim unpaid rent if you use cash-basis accounting. The reason is you have nothing to deduct. Since you never got the cash, you never had the unpaid rent become part of your income. You will pay less in taxes because your income is now lower. But getting an extra deduction would be double dipping.
Is unpaid rent tax deductible if you use accrual-basis accounting?
You may use accrual-basis accounting if you’re a larger landlord or your accountant told you to. This means you enter rent in your books whenever it’s due. If your rent is always due on the 1st, you record it on the 1st whether your tenants pay early or late.
If you entered rent in your income that you never got, you can take a bad debt tax deduction. The bad debt deduction is equal to the amount of unpaid rent. To take a bad debt deduction, you generally need to have little to no chance of collecting the unpaid rent now or in the future. If you do manage to collect full or partial payment after you’ve taken the deduction, you’ll need to add that payment back to your income. The main idea is that you should get taxed on the exact amount of rent you received.
If you decide to waive or discount rent for tenants who have a hardship due to coronavirus, you’d enter that on your books like any other discount. You’d then only get taxed on the actual amount that they pay not the full normal rent.
Can you deduct other rental expenses associated with unpaid rent?
When a tenant doesn’t pay rent, it may cost you more than the lost rental income.
You might pay a lawyer or collection agency to try to get the tenant to pay. You may also have to pay court filing fees for an eviction plus other administrative expenses like postage for notices.
In some cases, an eviction can lead to a tenant trashing your rental property and you having to pay to restore it. Even if the tenant leaves without causing damage, there are the usual expenses of finding a new tenant and preparing the rental unit.
All of the above are generally deductible expenses. That’s because they’re actual expenses that you had to pay to operate your rental business.
What if you take a loss for the year?
In some situations, your rental expenses might exceed your rental income for the year. This gives you a net loss.
The tax treatment of a loss depends on how you operate.
The general rule for passive income activities is that you can’t deduct losses from your other income (such as wages or self-employment). You can carry those losses forward to offset passive income in future years.
Active Participation in Management
If you have a passive real estate activity but actively participate in the management of your property, you may be able to deduct up to $25,000 of your losses against your other income.
To receive the full deduction, you need a Modified Adjusted Gross Income under $100,000. The deduction goes to $0 when your Modified Adjusted Gross Income reaches $150,000. (If you’re married filing separately, the deduction and income limits are cut in half.)
Real Estate Professionals
If you qualify as a real estate professional, you may be able to deduct your full losses from other income as your real estate activity would no longer count as a passive activity.
Qualifying as a real estate professional generally means that you’re acting as a full-time landlord or at least more than half of your working hours on your real estate business.
What if you gave a tenant a payment plan?
If you gave a tenant a payment plan so they could catch up on unpaid rent, the tax rules stay the same.
If you use the cash method, you include the payments in your rental income when you receive them. A cash basis taxpayer can’t claim unpaid rent in the meantime, because you never reported income from that tenant.
If you use the accrual method, you would generally report the rent as income when it was originally due. Since you expect the tenant to pay, you generally can’t take a bad debt expense for the missed payments.
If your payment plan includes interest, you will also need to report the interest income. If you use the cash method, report interest when you receive it. If you use the accrual method, report interest according to the terms of your payment plan.
Do landlords pay taxes on rental assistance?
In most cases, landlords will pay taxes on rental assistance. This can either apply to COVID-19 rental relief or permanent rental assistance programs.
If the assistance is paid on behalf of the tenant, this will almost always be taxable income. It’s the same as the tenant paying in cash.
If you receive a grant from the government that isn’t tied to a specific tenant’s rent, this will also generally be taxable income.
- The purpose of the tax rules is to make sure you recognize rental income you receive.
- You can generally only deduct unpaid rent if you reported it as income under the accrual method but never received it and won’t receive it in the future.
- You can still deduct your other business expenses.
- There may be limits to the losses you can take on your overall tax return, but you can often use excess losses to offset taxable income in future years.