Question

The Bluejay Apartments is a new development and is in the process of structuring its lease agreements. The company would like to set the damage deposits high enough that tenants will keep the apartments in good condition. The company is actually more concerned about damage than about tenants not paying their rent.
a) Discuss the tax effects of the following alternatives:
i. $1,000 damage deposit with no rent prepayment�
ii. $500 damage deposit and $500 rent for the final month of the lease
iii. $1,000 rent for the final two months of the lease and no damage deposit
b) Which option do you recommend

Answer 1

Answer:

The Bluejay Apartments

1. Tax Effects of the following Alternatives:

i. $1,000 damage deposit with no rent prepayment

No tax will be paid by The Bluejay Apartments until the deposit will no longer be refunded.

ii. $500 damage deposit and $500 rent for the final month of the lease

Tax will be paid on the rental income of $500 and on the $500 if it will no longer be refunded.  If it is taken as part of the rent income for a month, then tax will be paid on a total income of $1,000.

iii. $1,000 rent for the final two months of the lease and no damage deposit

Tax will be paid on the rent income of $1,000.

b) From a tax point of view, option i is recommended.

Step-by-step explanation:

According to the IRS, a security or damage deposit is not taxable when it is received by the landlord.  It becomes taxable income when the landlord is no longer obligated to return it to the tenant.  The reason a damage deposit is not taxed is that it is recorded as an asset and not an expense or income.