The Money Mustache Community
Learning, Sharing, and Teaching => Taxes => Topic started by: Mighty-Dollar on November 07, 2016, 01:05:34 AM
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If landlord and tenant agree to allow the landlord to use part of the security deposit towards rent, and that rent is not due until Jan 1, 2017, as far as the IRS is concerned, what tax year is that rent applied to if the deposit was initially collected in 2016?
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I don't have a source to cite, but I would assume that it converts to rent on the day the agreement is made to apply the deposit towards rent. The landlord is holding the deposit, therefore already having taken receipt of the funds.
That day you have a meeting of the minds and a (hopefully written) agreement to treat the security deposit as rent and you also have actual receipt. It is rental income to the cash basis taxpayer.
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This is actually a surprisingly complex question, and the answer presumably depends on state law. See Burnet v. Harmel, 287 US 103 (https://scholar.google.com/scholar_case?case=14927444189984824348), 110 (1932) ("The state law creates legal interests but the federal statute determines when and how they shall be taxed.")
In some states, such as California, the relationship between the landlord and tenant relative to the security deposit is that of debtor and creditor. Korens v. Zukin, 212 Cal App 3d 1054 (https://scholar.google.com/scholar_case?case=16123856357672762990), 1059 (Ct App 1989). In these states, at the commencement of the tenancy, the landlord basically receives loan proceeds from the tenant and is then obligated to repay that loan in the future, subject to lawful deductions. The receipt of these loan proceeds is not gross income because the received asset is, at the time of receipt, offset by an equal liability (the obligation to repay the proceeds). United States v. Kirby Lumber, 284 US 1 (https://scholar.google.com/scholar_case?case=9002232985618410374) (1931). However, "[t]he moment it becomes clear that a debt will never have to be paid", the amount is then included in gross income. Cozzi v. Commissioner, 88 TC 435 (https://scholar.google.com/scholar_case?case=4033416144292983692), 445 (1987). This moment is presumably when the landlord and tenant agree that the landlord will apply a portion of the security to the January 1, 2017 rent, because at that moment (even though it might be in 2016), the landlord knows that he or she will never have to repay that portion of the security and has therefore realised gross income.
However, in other states, such as New York, the relationship between the landlord and tenant is that of trustee and beneficiary. See McMaster v. Pearse, 9 Misc 3d 964 (https://scholar.google.com/scholar_case?case=4947738213818830973), 967 (Civ Ct NY 2005) and cases cited therein. Under this model, the security is not an asset of the landlord when received. New York General Obligations Law § 7-103 (http://codes.findlaw.com/ny/general-obligations-law/gob-sect-7-103.html)(1). In these states, the security, or a portion thereof, presumably does not become gross income until the earlier of (1) the date on which, under the agreement between the landlord and tenant, the security becomes an asset of the landlord (presumably January 1, 2017 when it is used toward the rent), or (2) the date on which the landlord actually converts the money to his or her own use (e.g. by commingling it with personal funds).
For the purpose of this analysis, I have grouped state laws into two broad categories, but in reality every state has different laws. Therefore, in your particular state, it may be the case that neither of my possible analyses is correct. You will have to analyse the specific laws of the state in question. The analysis may also be affected by the precise terms of the agreement or agreements between landlord and tenant. As such, I cannot express any view on the specific circumstances of the original poster.
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In some states, such as California, the relationship between the landlord and tenant relative to the security deposit is that of debtor and creditor. Korens v. Zukin, 212 Cal App 3d 1054 (https://scholar.google.com/scholar_case?case=16123856357672762990), 1059 (Ct App 1989). In these states, at the commencement of the tenancy, the landlord basically receives loan proceeds from the tenant and is then obligated to repay that loan in the future, subject to lawful deductions. The receipt of these loan proceeds is not gross income because the received asset is, at the time of receipt, offset by an equal liability (the obligation to repay the proceeds). United States v. Kirby Lumber, 284 US 1 (https://scholar.google.com/scholar_case?case=9002232985618410374) (1931). However, "[t]he moment it becomes clear that a debt will never have to be paid", the amount is then included in gross income. Cozzi v. Commissioner, 88 TC 435 (https://scholar.google.com/scholar_case?case=4033416144292983692), 445 (1987). This moment is presumably when the landlord and tenant agree that the landlord will apply a portion of the security to the January 1, 2017 rent, because at that moment (even though it might be in 2016), the landlord knows that he or she will never have to repay that portion of the security and has therefore realised gross income.
I'm in California so it looks like it's the moment that the funds are to be applied towards rent, changing from security deposit to rent.