California Real Estate Practice Exam

The first and last months' rent payments were collected by the lessor, leasing a single family residence. The prepaid rents received would be reported on income tax:

1. All in year in which last month occurs

2. In year received totally

3. Split between year received and year in which last month would occur

4. Would not need to be reported because they were prepaid

The correct answer is: All in year in which last month occurs

When it comes to reporting prepaid rent for tax purposes, the correct approach aligns with how the payments are recognized as income. According to tax regulations, the lessor must report rental income in the year it is earned rather than the year it is received. In this case, prepaid rent that covers both the first month and the last month will be recognized differently. The rent payment for the first month is recognized in the year it is received since it is earned at that time. The last month's rent, however, is not earned until the last month of the lease term. Therefore, while the lessor receives this payment upfront, it is not considered income until the actual time period it covers, which falls into the future. Thus, the total prepaid rent, comprising both the first month's rent recognized in the current year and the last month's rent recognized in the year it becomes due, is reported in the year in which the last month's period occurs. This method ensures that the rent income aligns with the corresponding rental periods, adhering to the accrual accounting principles typical in real estate transactions. This understanding of income recognition is crucial as it helps ensure that the tax implications are accurately reflected based on when the income is actually earned rather than simply when it is received.