Prepaid Rent Income

[Thom]

I have a couple who moved in Jan 2012 and had a contract to sell their previous house. Buyers couldn't obtain loan and decided to rent until they were able. Buyers prepaid all of 2012 rent in Jan 2012. In the fall of 2012, they prepaid all of 2013 rent. After filing their 2012 return, buyers were able to obtain mortgage and the house was closed in Feb 2013 with all of the remaining year's rent returned to buyer at that time. The couple received a 1099 for 2012 showing all of the rent for both years. I am wondering how to show this refunded rent on the return. Can I take it off of 2012 Sch. E even though it wasn't returned until 2013?

[kcjenkins]

They actually had the money in 2012, so I do not see any way to remove it as income for 2013. The refund will need to be shown next year. As an adjustment to the sale, I'd assume.

[Janitor Bob]

If you were a store owner and you made a cash sale to a customer in 2012 and then customer returned the item for a refund in 2013, the sale/income would still be reported by the store-owner in 2012....With a corresponding expense/return in 2013.

I would assume the rental situation above would be similar.

assuming taxpayer is on cash-basis and not accrual basis for reporting.

[Thom]

I understand what you're saying about the store. But in theory the store would be ongoing and have more sales the next year. This is their only rental. I guess I'm having a hard time imagining a 2013 Schedule E with 0 rent income and nearly 20,000 in rent returned. But that would represent what actually occurred.

[jainen]

>>The couple received a 1099<<

That's weird. Was it business property for the buyers?

Well, I'm in a sympathetic mood today and I don't think it's fair to tax them on money they KNOW they weren't able to keep. They were under contract so it was like a rent-to-own arrangement. Call it a deposit pending sale, and exclude the amount later refunded.

Of course, warn the taxpayers there is a good chance of getting an IRS letter but you can handle it. After all, it was a one-time thing for which the net income is the same either way, so it is not tax-motivated to show the numbers as a single transaction. If an auditor wants to argue, say you would rather characterize it as additional sales proceeds, totally excluded under Section 121. Keep talking jive like that until the auditor gives up.

[Thom]

The couple moved out of state. Even though they were receiving the first year's rent up front they hired a management firm because they wanted someone to check on the property periodically and to manage maintenance/repairs if anything was needed. The rent must have passed through the management firm because that is who issued the 1099. I'm trying to come up with a correct way to handle this that won't lead to an IRS letter but I'm not coming up with one.

[jainen]

>>a correct way to handle this that won't lead to an IRS letter<<

If your standard for "correct" is avoiding an IRS inquiry, report the total income in 2012. In 2013, deduct or credit the repayment in accordance with page 88 of Pub 17. (Don't worry about the clients--since they moved out of state, they won't come back to you anyway.)