Wednesday, July 06, 2005

Are You Collecting Sales Tax On Your Rentals?

This article in my local newspaper highlights an important issue with landlords: many are not aware they are supposed to be collecting city sales tax on their rental income. In addition to the sales tax, I discovered you also need to register the property as a rental property with the county. What happens if you don't do this? Penalties vary by city, but you could face fines of up to 25% of the value of back taxes owed, plus a fine of $1,000 for not registering the property as a rental property. Lack of manpower meant that, in the past, you could fail to do these things and manage to escape detection fairly easily. However, with the real estate boom and the large increase in the number of rental properties, cities have realized this is now a huge source of revenue they are missing out on and are starting to throw resources at it. Chandler, Arizona hired an ASU grad student to search through real estate and utility records looking for mismatches, which may indicate rental units. So far, they've collected $33,000.

When I first got my rental property, I didn't know I needed to collect tax until my CPA mentioned it. It wasn't a big deal, but it did mean I had to pay $20 a month in sales tax, plus about $50 a year for a sales tax collection license. Had I known I needed to collect tax, I would have included it in the rent I charged my tenant. Instead, I had to take a drop in my cashflow of $20 a month.


Ryan said...

Hi Shaun, great blog here!

I have a question about the $20 addition to the rent amount, had you know about it.
Say you're charging $500 per month for rent, but you need to add on a little to compensate for the sales tax.
That would bring the rent amount to $520
But wouldn't you have to calculate sales tax amount on the new $520 amount, thus adding to your sales tax that you're required to pay?
If that's the case, it seems like a catch-22 situation; raise rent to pay for sales tax, but if you raise rent, sales tax amount increases. Or am I thinking too much and there's a simple solution?

Shaun said...

It's all in how you word your lease agreement. If you just raised the rent to $520, yes, you'd be in the situation you described. But if you write the lease agreement so that the rent is "$500 plus x% sales tax" or $500 plus $20 sales tax," then you're ok.

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