Q:

Subject: Question about security deposit and 1099

We (the tenant) just received a 1099 for a refund of our security deposit (office space that we rented) from a previous landlord. It is my understanding that security deposit is not income to the landlord when received nor to the tenant when returned to the tenant. It would only convert to income if it is forfeited and that would be income for the landlord not the tenant.  Can you point me to some printed verification of my thought or tell me I am incorrect?

Thanks for your time

A:

How landlords treat the handling of security deposits is optional.

One way (and the technically correct way) is to book it when received into a liability account and not as income.  If it is later forfeited by the tenant, it is transferred from the liability account into the Rent Income account.  If it is repaid to the tenant, the check is posted to the same liability account as the deposit was and would thus not be a deduction from current year income.

Since that is a little too complicated for many people to keep track of, what is more commonly done in real life is for the landlords to use a more pure cash basis of reporting rental income and expenses.  Under this method, all monies received, including potentially refundable security deposits, are reported as rent income in the year received. Any security deposits refunded to tenants are then deducted as expenses in the year paid out.

As long as the security deposits are handled consistently under whichever method the landlord chooses, things will be fine.

This only applies to money specifically designated as security deposit and does not apply to any money paid by the tenant which is specified as Last Month’s Rent.  That is taxable income to the landlord in the year it is received, even though the last month could be several years away.

Here is an excerpt from Page 7-5 of the latest edition of The TaxBook, a reference source any good tax pro should have:

“Security deposits. A security deposit is not included in rental income when received if the property owner plans to return it to the tenant at the end of the lease. If any amount is kept during the year because the tenant did not live up to the terms of the lease, include that amount as rental income. If an amount called a security deposit is to be used as a final payment of rent, it is advance rent and is included as income in the year received.”

It seems like your landlord is probably using the second method of accounting for security deposits on his tax returns and is planning to claim the refund as an expense on his current tax return.

As your own personal professional tax advisor will most likely confirm, your treatment of the refunded security deposit on your tax return will need to be consistent with how you accounted for the original payment of that deposit.  If you followed proper accounting methodology and booked it into an asset account on your books, the refund will be posted to that same asset account and will not be income to you.

If, on the other hand, you deducted that payment as a rent expense, you will need to pick up the refund as either income or a reduction of the current year’s rent expense.  The latter would be the proper way to handle a refund of a previously deducted expenditure.

I hope this helps.  Your own professional tax advisor can give you more specific advice on this matter.

Good luck.

Kerry Kerstetter

Q:

Subject: Amortizing the cost of acquiring a mortgage

Hello Kerry:

Thank you for providing such wonderful information.

My question is rather simple.  I acquired rental property in 2007 and want to amortize the loan costs.  I understand how to calculate the amortization and that it is reported on line 18 (“Other”) of schedule E.  However, since I acquired the property (and mortgage)in 2007 I need to file Form 4562.  The amortization is done in Part VI of the form and everything is fairly straightforward except for 2 things. 
1) What do I list in column (d) – “Code section”?

I’ve searched the IRS site and the intranet high and low but can’t seem to find any information on this.  Form 4562 instructions list some codes, am I to use one of them?  The only one that seems to make sense is Section 197 – Certain intangibles.

2) If I put “Property A loan origination costs” as a description, can I use a 5 yr amortization like you suggest?  If I use code 197, am I stuck with a 15 yr term?

Thank you.

A:

When I enter a new loan costs item into the Lacerte depreciation schedule, I always choose Code Section 461 – Points as the appropriate amortization code section and manually enter the number of years that is appropriate for that particular item.  I’ve been doing that for over 20 years in Lacerte and IRS has never once had any problems with it; so that should work for you.

Kerry Kerstetter