Prospective tenant in Philadelphia, PA wants to pay for year long lease all up front. How does this impact net income and therefore taxes? Typically when paid on a monthly basis I am able to deduct depreciation of property to offset taxable income from the rent collection; some in 2023, some in 2024 as lease is [October ‘23, October ‘24]. With an all up front payment, all of the income would be in 2023, while the scheduled depreciation would not be able to offset the income, leading to substantially higher taxes. Unless I am misunderstanding, this seems detrimental. Normally the net tax comes out close to 0 since yearly depreciation covers the income. But if all of a sudden the income is all in 2023, depreciation wouldn’t be enough to net it out, thereby incurring non-zero taxes and causing me to pay more than I otherwise would have. The only way it nets to 0 delta over the 2 years is if home depreciation can be used to offset other income (ie salary) in 2024. Not sure if this is possible? Is this a correct understanding?
This is not entirely how it works, but it can cause some temporary cash-flow problems due to taxes shifting.
When you're paid for a whole year at once, you as a cash basis taxpayer recognize the income at once. Depreciation is always taken over time. So you can potentially get into a situation where you have higher tax liability in 2023 due to the lump sum payment, and then tax loss in 2024 due to the depreciation taken with no income to offset it.
It eventually balances out over time, but in 2023 you may have to pay a bit more in taxes and wait for a year to recoup it in depreciation. You can deduct rental losses from other income, but to a limit. It's called "passive activity loss" and there are non-trivial rules on how to handle it. See the IRS Publication 925. In 2024 you may end up with passive activity loss rules limiting how much of the loss you can actually use against other income, but it will also end up balancing out with future rental income or when you sell the property since you carry forward the passive activity losses that you cannot use until you can.
It is an inconvenience to you for sure, and unconventional. I'm not sure why the tenant wants it, since they also lose the value of the money for the whole year.