[TargetCPA]

William owns a four-unit apartment building for which he receives $500 per month per unit. Three of the units were rented for the entire 12 months. The fourth unit was occupied from January 1 to April 30, 2014. Upon vacating the unit the tenant was not refunded his security deposit of $500 due to damage to the unit. The unit was subsequently rented for 1 year beginning August 1, 2014. On August 1, 2014, the new tenant paid the first and last months’ rent and a refundable security deposit of $500. What is William’s rental income for 2014?

A. $22,500

B. $23,000

C. $23,500

D. $24,000

Answer (C) is correct.

Accrual-basis taxpayers report income when it is earned. All amounts received or accrued as rents are includible in income. Security deposits are income if and when the lessor becomes entitled to the funds by reason of the lessee’s violation of the terms of the lease. Advance rent received upon execution of a lease is includible in gross income in the year received, whether the taxpayer is on the cash or the accrual basis. For the current year, William must include $18,000 for the three units rented continuously during the year. Although not specifically stated, it is presumed that William received rental income of $2,000 from unit four while it was occupied for the first 4 months of the current year. The $500 security deposit of the first tenant in unit four is includible as rental income because William became entitled to the funds to repair damages to the unit after the tenant vacated it. William also received rental income of $3,000, which included $500 of prepaid rent, from the second tenant of unit four. The refundable security deposit of $500 paid by the second tenant of unit four is not part of William’s rental income for the current year because William was not authorized to retain any portion of the deposit during the year.

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3 units renting at $500/month for a whole year = $18,000

4th unit rent from Jan 2014 – April 2014 = ($500*4)+$500 for damages = $2,500

4th unit rent from Aug 2014 – Dec 2014 = $500*5 = $2,500

Answer should be $18,000+$2,500+$2,500 = $23,000 but Gleim shows $23,500 including 2nd tenant refundable security deposit.

Oops I missed the prepaid rent for the last month’s rent. Got it!!

[Anonymous]

Per the answer you posted: “Security deposits are income if and when the lessor becomes entitled to the funds by reason of the lessee’s violation of the terms of the lease”

From the facts: “Upon vacating the unit the tenant was not refunded his security deposit of $500 due to damage to the unit.”

So the lessor (landlord) was entitled to the $500 security deposit and is included in rental income because the lessee (renter) violated the terms of the lease by damaging the unit at the end of the lease.

[TargetCPA]

1st tenant: Refundable security deposit is not refunded to the tenant because he damaged the property. I thought when I am doing this MCQ, 2nd tenant's refundable deposit was added into Gross income. But it was not added into GI.

Prepaid rent for 1st month and last month rents at $500 per month is the only reason for extra $500+$23,000.

[Author]

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