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Chapter: 1800 Income Program: MSSI, SFP 18 1840.0504 Computation of Rental Income (MSSI, SFP) Net rental income is gross rent minus ordinary and necessary expenses paid or anticipated to be paid in the same taxable year. Ordinary and necessary expenses are those necessary for the production or collection of rental income. Expenses recognized by the IRS and paid during the same taxable year can be deducted from unearned rental income. Allowable expenses include:

1. real estate taxes, 2. interest on debts, 3. utilities, 4. maintenance, 5. repairs (i.e., minor correction to existing structure), 6. the cost of advertising for renters, 7. lawn service, 8. interest and escrow, and 9. homeowner's insurance.

Expenses of managing a rental property are allowable if the expenses are reasonable and necessary. To be considered reasonable, the charge for managing the individual's rental property is limited to 10% or less of the gross rental income, which should be the community standard charged by local real estate managers. Higher managing expenses may be allowed if the individual can present evidence (e.g., two statements from a knowledgeable source) that such charges are the standard in the particular geographic area of the property.

Unacceptable expenses include:

1. capital expenditures (i.e., an expense for an addition or increase in the value of property which is subject to depreciation for income tax purposes), and 2. the principal portion of the mortgage payment.

If it is uncertain whether an expense is allowable, contact the local IRS office for clarification.

To compute ongoing budget months when actual expenses are not yet known:

1. Include predictable, allowable expenses (for example, utilities, interest payments, real estate taxes, etc.). 2. Use the individual's most recent federal income tax return to estimate future rental expenses. 3. Count one-time allowable expenses (such as minor repairs) as allowed deductions beginning in the month following the month the expense is reported. (Remember, the expense must be paid in order to be an allowable deduction.)

Note: When the one-time expense exceeds the monthly rent payment, deduct the expense from the rental income in subsequent months until the expense is completely used.

To compute prior and current budget months include allowable expenses in the month paid, unless the expense exceeds the monthly rental income.

Note: If the one-time expense exceeds the monthly rent, deduct the expense from the rental income in subsequent months until the expense is completely used. (Expenses for current and prior months must be verified.)