When Should a Landlord Accrue Rents?

As the COVID-19 pandemic affects every aspect of our lives, we continue to see how the outbreak has negatively affected our economy too.  Every industry has been impacted by Coronavirus shutdowns.  One of the hardest hit industries is the real estate rental market. Whether you are a landlord or a tenant, you are feeling the impact.  As states work to slow the spread of COVID-19 by mandating business shutdowns, businesses have closed, and employees have been laid off — resulting in cash flow issues for landlords. In addition to dealing with cash flow issues, landlords also need to worry about the income tax implications of these circumstances.

Landlords using the accrual method of accounting may have to report these uncollected rents as income, creating taxable phantom income. This may require a landlord to use precious cash to pay income taxes on rents that may never be collected. Additionally, this could impact your ability to qualify for the Employee Retention Program.

When Must You Accrue Rental Income?

A landlord using the accrual method of accounting for tax purposes must report rents as income upon the earlier of the year in which the right to receive the payment is fixed and the amount can be determined with reasonable accuracy, or the inclusion of the rental income for financial accounting purposes. If your tenant defers payment to the following year, you are still required to report such payment as income in the current year.  This is most likely the case even if you subsequently modify the existing lease agreement for the deferral.

When May You Not Accrue Rental Income? 

A landlord using the accrual method of accounting for tax purposes may not need to accrue rents as income if the landlord’s ability to collect the rent is contingent upon a future event.  For example, your tenant will pay only if it (a business) or they (an individual or individuals) earn enough money to pay the rent.  If your only option is to agree or have a vacant space, you may not need to report the unpaid rents as income because nothing is payable to you until the contingency has been satisfied(the tenant earned sufficient cash to pay).

Suppose you don’t agree to your tenant’s request to defer rent payments.  You may still be able to exclude the unpaid portion of the rent if your waiting period for payment could be deemed as indefinite when it is due, especially in a pandemic situation in which many individuals and  businesses have to continuously overcome challenges brought upon by uncertainties.

Since many businesses were shut down or operating under substantial restrictions in response to the pandemic, the tenant’s business may have suffered due to these restrictions and may be struggling to sustain operations, let alone pay rents. Individuals may have been laid off and have little or no income coming in and have no prospects of employment until their employers’ businesses are allowed to open.

The business shut down is one example of a substantial restriction. Other examples include, but are not limited to:

• No indoor dine-in service
• Limited indoor capacity
• Substantial reduction of business hours

Where a landlord’s right to payment comes with substantial uncertainties at the time it arises, the landlord may not be required to accrue the rent. A careful analysis of your uncollected rent is an important step before preparing your 2020 tax return.

For more information on accrued rents or related topics, please contact Jeffrey Bowden at [email protected], Mark Schneider at [email protected], Rick Stieglitz at [email protected] or your Anchin Relationship Partner.