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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?

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  • You might consider asking them if they’d be willing to pay through Dec upfront, then pay the rest in Jan.
    – Charles
    Sep 30 at 1:14

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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.

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  • The main reason I can think of for wanting to pay a whole year up front is if the tenant cannot provide the proof of recurring income (at a certain multiple above the rent amount) that most landlords require for a regular lease billed monthly.
    – Douglas
    Sep 30 at 2:17
  • @Douglas I'd be wary of such a tenant. What happens at the end of the lease? Any explanation I can come up with makes me worry as a landlord, this just doesn't make much sense.
    – littleadv
    Sep 30 at 2:57
  • @littleadv: I was on the tenant side of this as a student. My parents were paying (my share of) the rent. The landlord wanted it up-front in order to avoid having to worry about the nonexistent credit of the average college student. As for what happens at the end of the lease - it's the end of the school year. We're moving out, and everybody understands this at the start.
    – Kevin
    Sep 30 at 20:29

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