1099-K Rental Income (Security Deposits)

[JohnH]

Client received a 1099-K from their rental management company because tenants paid by credit card.  The 1099-K amounts include two security deposits received in the same year (because a prospective tenant backed out and the owner refunded the deposit in full within a few days, plus it also includes the actual security deposit received from the replacement tenant).  So the 1099-K shows roughly $4K more in receipts that was collected in rent.  

Any suggestions on the best way to handle this?  Reducing the total gross rental income by the $4K produces a mis-match to the 1099-K (if there is any cross-checking with rental income).  Options for Schedule E seem to be: 1) Reduce the gross rental income on Schedule E to actual; 2) Report the full amount in gross rental income and then deduct the deposits under other deductions, perhaps as "Security Deposits reported on 1099-K in error"; 3) Report the 1099-K on a separate worksheet, subtracting the deposits with the same notation as in #2, and thus reporting the correct reportable gross rental income on Schedule E.  

Most any of these approaches could result in an inquiry a year or two from now, but I'm leaning toward  #3 as being preferable because it includes full disclosure and actually reports the correct gross rental income as the starting number on Schedule E.  Would appreciate any comments/opinions on this, as well as suggestions on any other ways to handle it. 

[BulldogTom]

My approach on rental deposits has always been that the amounts received are income (because the IRS says it is for cash basis taxpayers) and the return of deposits to the tenant at the end of the lease is an expense.   I put it on the other expense section of the Sch E as "refunded deposits".   

That looks like your second option.

Tom
Longview, TX

[JohnH]

Thanks for the reply, Tom.  I've always understood that even with a cash-basis taxpayer, a security deposit is not treated as income at the time received provided it is intended to be returned to the renter (minus any damages) at the end of the term, but is treated as advance rental income if the contract calls for it to be applied to the last rent payment.  But I'll be interested to hear what others might say about this as well.  I suppose part of the answer depends upon the language in the rental agreement. 

[DANRVAN]

Per IRS (also supported by case law):

Topic no. 414, Rental income and expenses

Security deposits – Don't include a security deposit in your income if you may be required to return it to the tenant at the end of the lease. If you keep part or all of the security deposit because the tenant breaks the lease by vacating the property early, include the amount you keep in your income in that year. If you keep part or all of the security deposit because the tenant damaged the property and you must make repairs, include the amount you keep in that year if your practice is to deduct the cost of repairs as expenses. To the extent the security deposit reimburses those expenses, don't include the amount in income if your practice isn't to deduct the cost of repairs as expenses. If a security deposit amount is to be used as the tenant's final month's rent, it is advance rent that you include as income when you receive it, rather than when you apply it to the last month's rent.