Collecting the monthly rent from a tenant is one of the most exciting things about owning real estate. Money received each month is used to pay normal operating expenses, cover the mortgage, and generate an income stream.
In this article, we’ll explain the different ways an investor can create a rental income worksheet, and how to keep track of rental income to help satisfy the requirements of the IRS.
Key takeaways
- Rental income includes any payment received for use or occupation of a rental property.
- Rent received and landlord expenses paid by the tenant are two examples of rental income.
- Security deposit from a tenant is generally not treated as rental income, except in certain situations.
- Rental income statements and a paper trail are two types of rental income records.
- Spreadsheets, personal finance programs, or software for real estate investors are 3 ways to keep track of rental income.
What is rental income in real estate?
Rental income is cash or the fair market value of property or services received for the use of real estate, according to IRS Topic No. 414.
Examples of rental income include:
- Rent received from a tenant, including additional rental income such as pet rent or late fees.
- Advance rent received, such as the first and last month of rent.
- Expenses paid by a tenant that normally belong to a landlord, such as repainting the house in exchange for waiving one month of rent.
- Fees received to cancel a lease agreement, including an early termination fee or a forfeited security deposit.
Note that security deposits are not included as rental income if the deposit is meant to be returned to the tenant at the end of the lease. Instead, the deposit is recorded as a liability (money owed to the tenant) on the rental property balance sheet.
However, if the deposit is subsequently used by a landlord to pay for a tenant’s unpaid rent or damage to the property, the security deposit becomes rental income when it is used to pay for rent or repairs.
When to record rental income
The IRS notes that most people operate rental property on a cash basis, which means that income is recorded when it is received.
For example, assume the rent on a home is $1,500 per month and a tenant moves in the middle of December. The landlord would collect a prorated rent of $750 for half of December plus $1,500 rent for the month of January, for a total of $2,250.
Because the landlord operates on a cash basis, the entire amount of rental income received would be recorded in December, even though part of the rent money received will be used to pay rent the following year.
If the landlord also collected a one month security deposit of $1,500, that amount would be recorded as a liability on the real estate balance sheet and not as rental income.
How to keep track of rental income
There are two types of rental income records a landlord keeps:
- Rental income statement
The first is an itemized list or report of rental income received, such as a rental property income statement. Information on the income statement includes:
- Date payment received
- Name of payer (usually the tenant)
- Payment amount received
- Form of payment (such as check or credit card payment)
- Purpose of the payment
- Property or unit number in a multifamily property the payment is intended for
- Rental income paper trail
The second type of rental income record is a backup document or paper trail for each income receipt.
Real estate investors use a paper trail to ensure that the correct amount of rental income is recorded to generate accurate financial statements and to prepare and export tax-ready financials at tax time.
Examples of a paper trail for rental income include:
- Bank statement showing that a tenant rent check was deposited or that an ACH (Automated Clearing House) transfer was received
- Copy of a tenant’s cancelled rent check downloaded from the bank’s website
- Monthly report from an online rent payment service such as Avail or TurboTenant showing income transactions received
While it’s possible to keep track of rental income using a handwritten ledger, it’s easy to accidentally enter incorrect information. Overstating or understating rental income can lead to problems with a tenant or complications with the IRS or the state in the event of a tax audit.
Options for a creating a rental income worksheet
There are three main options for a rental income worksheet. Some investors use a traditional spreadsheet, others use personal finance software they already have, while many investors choose software specifically designed for real estate investors.
Rental income spreadsheet
Spreadsheet software such as Excel, Google Sheets, Numbers, or OpenOffice can be used to create a basic rental income spreadsheet. Investors using a spreadsheet to keep track of rental income must take care to ensure that formulas are written properly so that balances shown at the end of each column and row are calculated correctly.
Although a rental income spreadsheet may be simple and easy to create, one of the drawbacks is that spreadsheet software can not easily sync to a business bank account used for a rental property.
Personal accounting software
Some investors use personal accounting software that they already have to track rental income, such as Quicken or TurboTax. Off-the-shelf accounting software will take a little time to set up to track rental income, because the programs aren’t specifically designed for real estate investors.
In order to use personal accounting software for real estate, a chart of accounts listing income and expense items, along with assets and liabilities, will need to be created. Then a tenant or customer will need to be created, and a test run done to ensure that income is accurately recorded and posted to the correct accounts.
Stessa for real estate investors
Stessa is an asset management software program created specifically for owners of residential income property. After signing for a free Stessa account, simply enter the property address and tenant information, connect bank accounts quickly and securely, and run financial reports like the income statement with just one click.
Owners of single-family rental homes, residential multifamily, and short-term rentals can track the income and expenses of an unlimited number of properties. Income and expense tracking is done automatically, investors can view real-time results via the performance dashboard at the property and portfolio level, and the paper trail that comes with real estate investing is created.
When tax time rolls around, owners can access the Stessa Tax Center to create a personalized tax package that includes an income statement, net cash flow report, and a ZIP file in a single email. Registered Stessa investors can also access a suite of tax resources created in partnership with The Real Estate CPA, and receive an exclusive TurboTax discount for members of the Stessa Community.
How to report rental income to the IRS
Real estate investors generally use Schedule E (Form 1040) to report income or loss from rental real estate. The information from Schedule E is also transferred to IRS Form 1040 or Form 1040-SR and included as part of an investor’s taxable income.
An investor selected for a state or federal tax audit may be asked to prove that income short on the tax return is accurate and not underreported. Typical records showing proof of rental property income include:
- Canceled checks
- Bank statements to show ACH deposits
- Year-end reports from an online rental payment service used by the landlord and tenant
Failure to provide satisfactory evidence to the tax auditor may result in additional taxes, penalties, and interest owed to the IRS and the department of revenue of the state the rental property is located in, along with the state where the investor resides.
Financial metrics that use rental income
Rental income is used in other financial formulas that help an investor to decide whether or not to purchase a property, and to forecast potential return on investment:
- Cash flow: Money remaining at the end of each period, after all rental income has been collected, and all operating expenses and the mortgage have been paid.
- Cash on cash return: Ratio that measures the annual pre-tax cash returned compared to the amount of cash invested.
- Net operating income (NOI): Total of all income received less all expenses paid, excluding capital expenses (CapEx) and the mortgage payment.
- Cap rate: Measures potential return from a rental property by dividing NOI by the property purchase price or market value.
- Price to rent ratio: Used by investors to predict potential demand for rental property by comparing the median home price to the median annual rent.
- Gross rent multiplier: Calculates potential profitability of a rental property by dividing property price by the expected gross rent.
Final thoughts
Rental income is one of the many metrics real estate investors use to identify potential opportunities to increase gross operating income and overall return on investment. While it’s possible to keep track of monthly income using a handwritten general ledger or conventional spreadsheet, many real estate investors opt for a system like Stessa to automatically keep track of rental property income and expenses.
