I have a couple tax questions that I hope you can help me with. Last summer I took a leave of absence from my job and spent a few months in Florida helping my elderly parents. By a stroke of luck, I was able to rent out my condo for a couple months when I was gone. When I took my tax information to my tax person, who is a friend of mine, he told me that I would have to pay taxes on that money. I was shocked; I never thought I’d have to pay taxes on renting out my own condo. My first question is just to confirm that my preparer is right. I’m hoping you can come up with a loop hole or something. My second question is what are my chances of getting caught if I don’t report it? I didn’t go through an agency and nothing was reported to the government.
Unfortunately, your tax preparer is correct. The money that you received as rental income, less expenses, is taxable to you as ordinary income. It doesn’t matter whether you used an agency or not, the money is taxable.
When someone rents out their owner-occupied home, the IRS gives that taxpayer a break. The break is if the taxpayer rents out their owner-occupied home for no more than 14 days a year, then all the rent received would be tax free. However, if you rent your house out for 15 days or more, the entire amount is taxable to you. Therefore, since you rented your property out for a few months, the entire amount is taxable.
The next question is one of the more difficult questions I get. The reason why it makes it so difficult is because it’s almost impossible to know the answer. I cannot tell you what your risk of being audited is. The IRS audits for a variety of things including for a sloppy or an inaccurate return, taking inappropriate deductions or failure to report income from a 1099. In addition, let’s not forget that you can do everything right and still be randomly audited. Furthermore, the person you rented your property to may treat the rental payments differently than you did and that can cause you issues if he is audited. The bottom line; you can be audited for a variety of reasons.
If you do not report the income and the IRS does audit you, not only would you have to pay the taxes, but they will also assess interest and potentially a penalty which can be severe. I always want to be honest so I will say that the chance of getting audited in this situation is slim. Particularly if the person you rented to is not deducting the rent on their tax return, however, that should not be the standard. The standard should be what the law says, and in this case the law is crystal clear.
My advice for people is that they should follow the tax law. Not only is it the law, and as citizens we have an obligation to follow the law, it will also make life easier. I cannot tell you how many people I’ve dealt with over the years who were overly aggressive on their taxes and who lived to regret it. Therefore, my advice is to always follow the law.
I am not suggesting that you do not take every deduction you’re entitled to, because you should. After all, it is not more patriotic to pay more money in taxes than you have to. However, if you get too aggressive, it could cost you and have other unexpected consequences.
Rick is a fee-only financial advisor. If you would like Rick to respond to your questions, please email him at Rick@bloomassetmanagement.com.