Is Landlord Double Dipping?

[Victor Roberts]

Here's a tax question posed to me by my son regarding some
of his friends.

Tenants of a rental property improve the property. The cost
of labor plus materials is $6000. Their landlord pays them
for the improvements by forgiving $6000 in rent payments.
The landlord issues a 1099-MISC for the $6000 cost of the
improvements to the tenants.

I understand that the tenants are obligated to pay
self-employment taxes on that portion of the $6000 that
represents their labor. (That is, the amount left over
after they deduct the cost of purchased materials from the
$6000 total on their Schedule C.

However, it seems that the landlord is getting to count the
$6000 as a deduction twice. First, he is obviously
deducting the $6000 as a maintenance or capital improvement
expense, or else he would not have issued the 1099-MISC.
Second, since he received $6000 less in rental receipts we
are assuming that he did not record as income the $6000 he
did not receive.

If he did not record the non-received $6000 as rental income
yet did deduct the $6000 as a maintenance or capital
improvement expense, would you agree that he has taken twice
the deduction he would be allowed?

 

[joetaxpayer]

Here's a tax question posed to me by my son regarding some
of his friends.

Tenants of a rental property improve the property. The cost
of labor plus materials is $6000. Their landlord pays them
for the improvements by forgiving $6000 in rent payments.
The landlord issues a 1099-MISC for the $6000 cost of the
improvements to the tenants.

I understand that the tenants are obligated to pay
self-employment taxes on that portion of the $6000 that
represents their labor. (That is, the amount left over
after they deduct the cost of purchased materials from the
$6000 total on their Schedule C.

However, it seems that the landlord is getting to count the
$6000 as a deduction twice. First, he is obviously
deducting the $6000 as a maintenance or capital improvement
expense, or else he would not have issued the 1099-MISC.
Second, since he received $6000 less in rental receipts we
are assuming that he did not record as income the $6000 he
did not receive.

If he did not record the non-received $6000 as rental income
yet did deduct the $6000 as a maintenance or capital
improvement expense, would you agree that he has taken twice
the deduction he would be allowed?

I had an AC unit fail. It was worth exactly two month's rent. The tenant
kindly handled the HVAC guy, and skipped two months. I claimed 12
month's rent on my Sch E, and added the AC unit as a capital
improvement, and started the depreciation.

Your son's friends are worse off. They now have a 1099. Even though they
should pay tax on the labor, it seems they have a 1099 for the full
amount. Landlord sounds like he slimed them.
Joe

www.blog.joetaxpayer.com

 

[Seth]

Tenants of a rental property improve the property. The cost
of labor plus materials is $6000. Their landlord pays them
for the improvements by forgiving $6000 in rent payments.

However, it seems that the landlord is getting to count the
$6000 as a deduction twice. First, he is obviously
deducting the $6000 as a maintenance or capital improvement
expense, or else he would not have issued the 1099-MISC.
Second, since he received $6000 less in rental receipts we
are assuming that he did not record as income the $6000 he
did not receive.

He should record the $6000 as income.

Seth

 

[Haskel LaPort]

Here's a tax question posed to me by my son regarding some
of his friends.

Tenants of a rental property improve the property. The cost
of labor plus materials is $6000. Their landlord pays them
for the improvements by forgiving $6000 in rent payments.
The landlord issues a 1099-MISC for the $6000 cost of the
improvements to the tenants.

I understand that the tenants are obligated to pay
self-employment taxes on that portion of the $6000 that
represents their labor. (That is, the amount left over
after they deduct the cost of purchased materials from the
$6000 total on their Schedule C.

However, it seems that the landlord is getting to count the
$6000 as a deduction twice. First, he is obviously
deducting the $6000 as a maintenance or capital improvement
expense, or else he would not have issued the 1099-MISC.
Second, since he received $6000 less in rental receipts we
are assuming that he did not record as income the $6000 he
did not receive.

If he did not record the non-received $6000 as rental income
yet did deduct the $6000 as a maintenance or capital
improvement expense, would you agree that he has taken twice
the deduction he would be allowed?

The very fact that the landlord issued a 1099 tells me that he/she knows
what they are doing and will most likely pick up rental income for $6,000.

That said, how the landlord records this transaction should not concern your
son's friends.

Your son's friends sound like fine upstanding young men and I'm certain,
even in the absense of receving a 1099, they would still report the income
earned.

 

[Barry Margolin]

Here's a tax question posed to me by my son regarding some
of his friends.

Tenants of a rental property improve the property. The cost
of labor plus materials is $6000. Their landlord pays them
for the improvements by forgiving $6000 in rent payments.
The landlord issues a 1099-MISC for the $6000 cost of the
improvements to the tenants.

I understand that the tenants are obligated to pay
self-employment taxes on that portion of the $6000 that
represents their labor. (That is, the amount left over
after they deduct the cost of purchased materials from the
$6000 total on their Schedule C.

However, it seems that the landlord is getting to count the
$6000 as a deduction twice. First, he is obviously
deducting the $6000 as a maintenance or capital improvement
expense, or else he would not have issued the 1099-MISC.
Second, since he received $6000 less in rental receipts we
are assuming that he did not record as income the $6000 he
did not receive.

If he did not record the non-received $6000 as rental income
yet did deduct the $6000 as a maintenance or capital
improvement expense, would you agree that he has taken twice
the deduction he would be allowed?

For tax purposes, I think this should be treated as if the tenants paid
the rent (and he reports it as rental income) and then he wrote them a
check for $6,000 (so he issues a 1099 to the tenants and reports it as a
business expense). He took a shortcut by forgiving the rent payments,
but that should have no tax consequences.

 

[removeps-groups]

Tenants of a rental property improve the property.  The cost
of labor plus materials is $6000.  Their landlord pays them
for the improvements by forgiving $6000 in rent payments.
The landlord issues a 1099-MISC for the $6000 cost of the
improvements to the tenants.

http://www.irs.gov/publications/p527/ar02.html#d0e228

<Quote>

Expenses paid by tenant. If your tenant pays any of your expenses,
the payments are rental income. You must include them in your income.
You can deduct the expenses if they are deductible rental expenses.
See Rental Expenses, later, for more information.

</Quote>

<Quote>

Uncollected rent. If you are a cash basis taxpayer, you do not
report uncollected rent. Because you do not include it in your income,
you cannot deduct it.

I understand that the tenants are obligated to pay
self-employment taxes on that portion of the $6000 that
represents their labor.  (That is, the amount left over
after they deduct the cost of purchased materials from the
$6000 total on their Schedule C.

Actually, I don't think it's self-employment income. If it were
periodic, then maybe. Therefore only report it on line 21 Other
Income. There is no social security tax, but there will be federal
tax. I hope you don't have an estimated tax penalty.

However, it seems that the landlord is getting to count the
$6000 as a deduction twice.  First, he is obviously
deducting the $6000 as a maintenance or capital improvement
expense, or else he would not have issued the 1099-MISC.
Second, since he received $6000 less in rental receipts we
are assuming that he did not record as income the $6000 he
did not receive.  

Not sure if what you say is right. Say your annual rent is 12k. His
rental income would be 12k. Then say he made the improvement of 6k,
so he would depreciate over a period of years, say for example 1k a
year. So net income first year is 12-1=11k.

But if you fixed the item, then he reports rent income as 6k plus the
expenses paid by tenant of 6k. So net rental income is still 12k.
And first year depreciation is 1k. So taxes for the landlord are the
same.

Say you're in the 25% tax bracket. In the first case your net tax is
T and savings as the end of the year is S. In the second case, you
pay 0.25*6000=1500, but then again you saved 6k on rent payments so
your savings are 4500 and the governments take is 1500. By giving you
a 1099-MISC for 6k, it seems the landlord invented 6k out of thin air,
like a printing press.

Similar thing happens when companies issue stock, which I don't quite
understand. If they issue 10000 new shares and market price is $10 a
share, then it's as if they printed 100,000 out of thin air. But
isn't the government the only one able to print money?

If he did not record the non-received $6000 as rental income
yet did deduct the $6000 as a maintenance or capital
improvement expense, would you agree that he has taken twice
the deduction he would be allowed?

Yes to the paragraph above.

 

[Victor Roberts]

I had an AC unit fail. It was worth exactly two month's rent. The tenant
kindly handled the HVAC guy, and skipped two months. I claimed 12
month's rent on my Sch E, and added the AC unit as a capital
improvement, and started the depreciation.

Your son's friends are worse off. They now have a 1099. Even though they
should pay tax on the labor, it seems they have a 1099 for the full
amount. Landlord sounds like he slimed them.

In spite of the fact that the 1099 includes the full $6000,
they can certainly file a Schedule C and deduct the cost of
the materials purchased for the job.

 

[Victor Roberts]

The very fact that the landlord issued a 1099 tells me that he/she knows
what they are doing and will most likely pick up rental income for $6,000.

That said, how the landlord records this transaction should not concern your
son's friends.

Your son's friends sound like fine upstanding young men and I'm certain,
even in the absense of receving a 1099, they would still report the income
earned.

Which they plan to do, after they deduct the cost of the
materials purchased for the job on their Schedule C.

 

[Mark Bole]

"Cost of labor" is not the correct term, unless the tenants hired an
employee or subcontractor to do the work. Your own labor is not a cost
to you, for tax purposes.

Their landlord pays them

He didn't forgive any rent. It was a bartering (cashless) business
transaction, with a fair market value of $6,000 (determined by two
parties with adverse economic interests in an arm's-length transaction).
As already noted, each side had $6,000 of income.


The self-employment tax is based on their net profit, not just their
labor. If they were smart and added a mark-up to the materials(1), they
pay SE tax on that too. If their net profit was low enough
(approximately $433), they won't even owe that, just income tax.

(That is, the amount left over
And after they also deduct any other ordinary and necessary business
expenses, such as business use of a vehicle to pick up materials and
supplies for the job, small hand tools, etc.

[...]

Your son's friends are worse off. They now have a 1099. Even though they
should pay tax on the labor, it seems they have a 1099 for the full
amount. Landlord sounds like he slimed them.

Not really. If they had paid the rent in cash from wage income, they
still would have paid (directly and indirectly through their employer)
full FICA taxes on the equivalent labor. They also didn't have to incur
non-deductible expenses such as commuting, as they would with wage
income. Plus, they were able to schedule the work at their own
convenience, rather than have their privacy and peaceful enjoyment
interrupted by the schedule of some outside contractor hired by the
landlord.

(1) not sure if that would trigger a sales tax obligation for the
mark-up, assuming they paid sales tax on their purchase price.

-Mark Bole

 

[D. Stussy]

"Cost of labor" is not the correct term, unless the tenants hired an
employee or subcontractor to do the work. Your own labor is not a cost
to you, for tax purposes.



He didn't forgive any rent. It was a bartering (cashless) business
transaction, with a fair market value of $6,000 (determined by two
parties with adverse economic interests in an arm's-length transaction).
As already noted, each side had $6,000 of income.

And under this view, the 1099-MISC is the wrong document to file for the
transaction. 1099-B is the correct document. However, see below.

The self-employment tax is based on their net profit, not just their
labor. If they were smart and added a mark-up to the materials(1), they
pay SE tax on that too. If their net profit was low enough
(approximately $433), they won't even owe that, just income tax.

(That is, the amount left over
And after they also deduct any other ordinary and necessary business
expenses, such as business use of a vehicle to pick up materials and
supplies for the job, small hand tools, etc.

[...]

Your son's friends are worse off. They now have a 1099. Even though they
should pay tax on the labor, it seems they have a 1099 for the full
amount. Landlord sounds like he slimed them.

Not really. If they had paid the rent in cash from wage income, they
still would have paid (directly and indirectly through their employer)
full FICA taxes on the equivalent labor. They also didn't have to incur
non-deductible expenses such as commuting, as they would with wage
income. Plus, they were able to schedule the work at their own
convenience, rather than have their privacy and peaceful enjoyment
interrupted by the schedule of some outside contractor hired by the
landlord.

(1) not sure if that would trigger a sales tax obligation for the
mark-up, assuming they paid sales tax on their purchase price.

How is this a business transaction for the tenant? There's no FICA taxes
involved here. The landlord paid NOTHING (i.e. no check was issued), so the
1099 is erroneous. The tenant made a leasehold improvement, but we don't
know if it's permanent or will be removed when the lease is up, so there's
nothing TO the landlord either.

 

[Seth]

.. . .
How is this a business transaction for the tenant? There's no FICA taxes
involved here. The landlord paid NOTHING (i.e. no check was issued), so the
1099 is erroneous. The tenant made a leasehold improvement, but we don't
know if it's permanent or will be removed when the lease is up, so there's
nothing TO the landlord either.

I don't think a landlord would foregive $6,000 of rent in return for
improvements that will be taken by the tenant, do you?

The tenant made improvements, in return for $6,000 worth of rent.

Seth

 

[Dick Adams]

Tenants of a rental property improve the property.
The cost of labor plus materials is $6000. Their
landlord pays them for the improvements by
forgiving $6000 in rent payments. The landlord
issues a 1099-MISC for the $6000 cost of the
improvements to the tenants.

This is clearly a barter transaction. The tenants
should ask the landlord to void the 1099-MISC and
issue a 1099-B. However, as others have pointed out,
this can be handled on a Schedule C without issuing
the a 1099.

I understand that the tenants are obligated to pay
self-employment taxes on that portion of the $6000
that represents their labor. (That is, the amount
left over after they deduct the cost of purchased
materials from the $6000 total on their Schedule C.

Since the word "tenants" was used, I presume there
two or more people involved. If so, the tenant who
received the 1099-MISC declares the income, writes
off all expenses, and issues 1099's to the other
tenants.

However, it seems that the landlord is getting to
count the $6000 as a deduction twice. First, he
is obviously deducting the $6000 as a maintenance
or capital improvement expense, or else he would
not have issued the 1099-MISC.

He should capitalize the $6000 as he had no expenses.

Second, since he received $6000 less in rental
receipts, we are assuming that he did not record
as income the $6000 he did not receive.

He didn't receive any income.

If he did not record the non-received $6000 as
rental income yet did deduct the $6000 as a
maintenance or capital improvement expense,
would you agree that he has taken twice the
deduction he would be allowed?

Maybe he did and then again maybe he didn't.
His accounting transactions are between him
and an IRS auditor.

Dick

 

[Taylor]

Which they plan to do, after they deduct the cost of the
materials purchased for the job on their Schedule C.

Unless they are in the improvements business, they don't need to have a
Schedule C and pay SE tax. Just put it on the 1040 under misc income.

 

[Victor Roberts]

Unless they are in the improvements business, they don't need to have a
Schedule C and pay SE tax. Just put it on the 1040 under misc income.

But how do they deduct the cost of materials from the $6K if
they do not file a Schedule C?

 

[Seth]

He should capitalize the $6000 as he had no expenses.

Shouldn't that depend on the form of the "improvements", how much is
deductible and how much capitalizable? (Consider NYC's doctrine of
"repair and deduct": if a landlord doesn't fix a problem, the tenant
is allowed to fix it and deduct the cost from his rent.)

He didn't receive any income.

He received $6000 worth of property improvements; why isn't that
considered income?

Seth

 

[removeps-groups]

But how do they deduct the cost of materials from the $6K if
they do not file a Schedule C?

Then they should file a Schedule C. Initially I thought they hired a
contractor whose cost of labor and materials was 6k, so they would
just report their 6k as Other Income. But if they bought 3k of
materials, and hired a contractor to do 2k of work, and themselves did
1k of work, then they should use a Schedule C which will end up
showing a profit of 1k, and SS and federal and state tax only on this
1k.

 

[Harlan Lunsford]

But how do they deduct the cost of materials from the $6K if
they do not file a Schedule C?

I'm not sure the OP was clear on this point. But are/is the lessee
actually in business and renting business premises from the lessor?

That's the impression I got anyway.

ChEAr$,
Harlan Lunsford, EA n LA

 

[Mark Bole]

Victor Roberts wrote: [...]

Tenants of a rental property improve the property. The cost
of labor plus materials is $6000. Their landlord pays them
for the improvements by forgiving $6000 in rent payments. [..,.]
However, it seems that the landlord is getting to count the
$6000 as a deduction twice. First, he is obviously
deducting the $6000 as a maintenance or capital improvement
expense, or else he would not have issued the 1099-MISC.
Second, since he received $6000 less in rental receipts we
are assuming that he did not record as income the $6000 he
did not receive.

[...]
I'm not sure the OP was clear on this point. But are/is the lessee
actually in business and renting business premises from the lessor?

That's the impression I got anyway.

I assumed they were residential tenants and the landlord in a passive
rental activity. I also assumed that this deal was agreed-to in advance
via an arm's-length transaction.

But regardless of business vs. residential, and regardless of what kind
of 1099 was or was not issued, the tenants received $6K rental value for
doing something they anticipated would cost them less than $6K to
provide -- otherwise, why would they do it? I use "cost" here in the
economic sense, not the tax sense.

Therefore they have gross income of $6K in a for-profit activity and owe
taxes on the net profit. If they totally miscalculated and have
legitimate expenses (for example, accidental breakage) that actually
exceed $6K, they would have a business loss (which might inspire them to
close up shop and never try that business again).

But for the month or two they did the work, they were in business (or
else they were employees of the landlord, but let's not go there).

The landlord also received $6K rental income, against which he can
deduct some combination of repair expenses and depreciable capital
improvements which add up to $6K (so, no, he is not double dipping).

It was a barter exchange. See the first two paragraphs under "Bartering"
and Example 4 on page 18 of 2007 Pub 525, which is almost exactly this
same scenario. In Example 4, the tenant is an artist, which could be
either a hobby or a business. It seems unlikely to me that the tenants
in our example do this kind of thing as a hobby.

-Mark Bole

 

[dpb]

Mark Bole wrote:
....

I assumed they were residential tenants and the landlord in a passive
rental activity. I also assumed that this deal was agreed-to in advance
via an arm's-length transaction.

But regardless of business vs. residential, and regardless of what kind
of 1099 was or was not issued, the tenants received $6K rental value for
doing something they anticipated would cost them less than $6K to
provide -- otherwise, why would they do it? I use "cost" here in the
economic sense, not the tax sense.

Therefore they have gross income of $6K in a for-profit activity and owe
taxes on the net profit. If they totally miscalculated and have
legitimate expenses (for example, accidental breakage) that actually
exceed $6K, they would have a business loss (which might inspire them to
close up shop and never try that business again).

But for the month or two they did the work, they were in business (or
else they were employees of the landlord, but let's not go there).

The landlord also received $6K rental income, against which he can
deduct some combination of repair expenses and depreciable capital
improvements which add up to $6K (so, no, he is not double dipping).

It was a barter exchange. See the first two paragraphs under "Bartering"
and Example 4 on page 18 of 2007 Pub 525, which is almost exactly this
same scenario. In Example 4, the tenant is an artist, which could be
either a hobby or a business. It seems unlikely to me that the tenants
in our example do this kind of thing as a hobby.

I don't see anything at all out of the ordinary for a couple guys who
are relatively handy essentially volunteering some work to make
improvements for cost irrespective of their day jobs. I certainly did
it often enough as a young pup right out of school when $$ were tight
and it was easier to get something improved if could do it oneself
rather than expect the landlord to deal with something that really
wasn't necessarily broke, just could be better.

In those days, never had a 1099 issued, but they were simpler times and
landlords weren't professional landlords, either; just renting an
earlier house or even earlier a widow lady taking in students in the
basement of her house...

--

 

[Ernie Klein]

But regardless of business vs. residential, and regardless of what kind
of 1099 was or was not issued, the tenants received $6K rental value for
doing something they anticipated would cost them less than $6K to
provide -- otherwise, why would they do it?

For the same reason my daughter has provided labor and materials in
exchange of forgiveness of rent - to have the advantage of the
"improved" property while they lived there. There might not be a
profit motive at all other than to enjoy the improvements.