Troy, a cash basis taxpayer, owns an office building. His records reflect the following for 20X1. On March 1, 20X1, office B was leased for twelve months for $12,000. A $900 security deposit was received which will be used as the last month's rent. On September 30, 20X1, the tenant in office A paid Troy $3,600 to cancel the lease expiring on March 31, 20X1. The lease of the tenant in office C expired on December 31, 20X1, and the tenant left improvements valued at $1,400. The improvements were not in lieu of any required rent. Considering just these four amounts, what amount must Troy include in rental income on his income tax return for 20X1? a. $17,900
b. $17,000
c. $16,500
d. $13,800

c. $16,500

Explanation:

The rental revenue from office B must be included even though 3 months of rent belong to 20x2 = $12,000 + the $900 security deposit (last moth of rent). The $3,600 received for canceling the lease of office A should also be included. Total rental income = $12,000 + $900 + $3,600 = $16,500.

Cash basis taxpayers recognize revenue when they collect money, and recognize expenses when they pay for them. There are some exceptions that apply to prepaid expenses or unearned revenue. This is known as the 12 month rule. It means that if the cash collection or payment do not extend for more than 12 months after they were made, then they can be recorded as either revenues or expenses during the current period. Since the rent was prepaid in advance for 12 months, then all the cash received must be considered revenue.