Accounting for Prepaid Rent
Dealing with rent that is collected before it's due (aka "prepaid rent") is a problem every commercial property owner should be so lucky to have. But collecting prepaid rent raises some tax questions about when to report the money on your tax return.
Prepaid rent is defined as rent paid before the rental period it relates to. Although rent usually is paid in advance — mostly on the first of the month to come — sometimes tenants pay several months before they plan to use the space. For instance, a tenant may pay rent in December for the upcoming quarter or two.
Commercial building owners typically use the accrual method of accounting, in which they report income in the year it is earned and record deductions in the year they are incurred.
Take note: "Earned" doesn't mean "collected," and "incurred" is different from "paid." Using the accrual method, tax returns are, to some degree, theoretical. You're reporting numbers that you expect will reflect money that comes in and goes out. The numbers, however, don't necessarily indicate actual dollars collected and spent.
How to report prepaid income
Generally, commercial real estate owners must add prepaid rent to gross income at the earliest of the following dates:
- The date you receive the payments.
- The date when the rent is due.
- The date you earn the income.
- The date you came into possession of the property title.
In other words, you typically must report on your income tax return prepaid rent in the year you received the payment, not when it is due.
For instance: Consider that you own a building and that you follow the accrual accounting method. If on December 2019 a tenant pays you $5,000 for January 2020 rent, you must report it on your 2019 tax return.
However, prepaid rent doesn't include payments you may receive for space in boarding houses, hotels, motels or apartment buildings that provide hotel services.
The accounting rules are different for tenants, who must deduct on their taxes prepaid rent in the year in which the company actually uses the space. On accounting records, the prepaid rent starts as a prepaid asset on the day the check is cut, and then it becomes a rent expense on the day the space actually is used.
Prepaid rent should be a problem that every commercial real estate owner has to face. But accounting for it can be a little tricky. Give us a call, and we'll help you manage prepaid rent so you can account for it in a timely and advantageous way.