How To Accurately Account For First And Last Month’s Rent

There are several aspects to consider if you want to benefit from collecting the first and last month’s rent while staying within legal guidelines.

Collecting the first and last month's rent upfront is a strategy that many landlords and property managers use to mitigate the risk of late and missed rent payments. However, it’s not always as simple as collecting double the rent. 

There are several aspects to consider if you want to benefit from collecting the first and last month’s rent while staying within legal guidelines. From understanding the reasons behind collecting prepaid rent to tracking and reporting this income at tax time to navigating the legal landscape. 

Why Do Landlords Collect First And Last Month’s Rent?

Collecting the first and last month's rent, also known as prepaid or advance rent, involves tenants paying the initial and final month's rent at the same time when they move.

By requiring this upfront payment, tenants are less likely to vacate prematurely, as they've already committed financially to the last month of their lease. Additionally, it acts as additional compensation in the event a tenant misses a rent payment or decide to move out before the lease concludes.

While collecting the first and last month's rent has its merits, there are considerations that landlords must weigh. This practice may complicate the eviction process, as tenants, having already paid for the final month, may feel entitled to remain until the lease's natural conclusion. Strained relationships with tenants can also arise, with some feeling burdened by the substantial upfront payment, potentially affecting the landlord-tenant dynamic and impacting a landlord's ability to find new tenants.

To navigate these challenges, it’s important to be fair and transparent. Communicating the rationale behind collecting the first and last month's rent is crucial for maintaining positive landlord-tenant relationships. And this should be clearly outlined in the lease agreement.

Why The Lease Matters When Applying The First And Last Month’s Rent

The lease agreement serves as the contractual framework that defines the financial and legal responsibilities of both parties. Landlords must explicitly articulate whether tenants are obligated to pay the first and last month's rent upfront in the lease document.

Landlords should also be aware that landlord-tenant laws around collecting prepaid rent and security deposits vary from state to state, and it is their responsibility to read up and be familiar with these to ensure they are acting within the confines of the law. 

Finally, maintaining meticulous records of lease agreements and financial transactions, including the collection of prepaid rent, becomes invaluable in the case of disputes or legal matters.

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Prorating When Collecting The First and Last Month’s Rent

While handling move-ins at the beginning of the month is relatively straightforward, accommodating tenants who wish to commence their lease before the standard start date introduces complexities. This is where the concept of prorated rent comes in.

Prorated rent is a practice that ensures tenants only pay for the specific days they occupy the rental unit. It is a fair and logical approach when tenants move in or out mid-month, preventing overcharging or undercharging for the rental period.

To calculate prorated rent you need to first determine a daily rent rate and then multiply that daily rate by the number of days the tenant occupies the property in that month.

To determine the daily rate, divide the monthly rent amount by the number of days in the month. For example, if you charge $2,000 a month and your tenant moves in on the 20th of June you would divide $2,000 by 30 which equals $66.67, and then you multiply this by 11 which is the number of days left in the month plus the day they moved in on (30-20+1).

The prorated rent in the above example would be $733.37.

It's crucial to note that certain jurisdictions impose limits on the amount landlords can collect in prepaid rent. Before proceeding, landlords must diligently check and adhere to local laws to avoid potential legal complications associated with collecting prepaid rent from tenants.

Is first and last month’s rent the same as a security deposit?

The first and last month’s rent is different than a security deposit. Property owners can only use security deposits to:

  • Pay for fixing damage to the unit sustained during the renter’s lease
  • Pay for the last month’s rent

Renters use first and last month’s rent to:

  • Pay the first and last month of rental dues before they move in and before or upon moving out
  • Begin and finish out their lease

Can You Collect A Security Deposit And The First And Last Month’s Rent?

In the majority of states, landlords have the authority to collect a security deposit equivalent to either one or two month's rent, and they may also have the option to gather the first and last month's rent in advance.

The practice of collecting both a security deposit and the first and last month's rent comes with its advantages and drawbacks. On the one side, it provides a safeguard for landlords in case of property damage or rent nonpayment. On the other hand, it can pose a financial challenge for tenants who must come up with a substantial upfront sum.

Given the variability of landlord-tenant laws across different states, landlords need should research and adhere to local regulations. Keeping meticulous records of all financial transactions related to the rental property is paramount, as this documentation serves as a valuable resource in the event of disputes, ensuring compliance with legal obligations.

Note: The security deposit does not qualify as taxable rental income unless it is applied to the final month of rent. The primary purpose of the security deposit is to shield the landlord from potential damage or nonpayment, not to generate profit.

You might like: The Complete State-By-State Guide To Security Deposit Laws

How To Accurately Account For The First And Last Month’s Rent

When you secure the first and last month's rent from a new tenant, you are essentially acquiring prepaid or advance rent. The crucial distinction lies in recognizing that the last month's rent, although designated for future use, is considered income in the current fiscal year. Therefore, it must be documented as income on your financial records.

The Internal Revenue Service (IRS) provides clarity on this matter in their guide, "Tips on Rental Real Estate Income, Deductions, and Recordkeeping." According to the IRS, any amount received before the period it covers is classified as advance rent. Regardless of the accounting method employed, landlords should include advance rent in their rental income for the year it is received.

For example, suppose you enter into a 12-month lease agreement with a tenant commencing on May 1. If you collect $1,000 for May's rent and an additional $1,000 designated for the last month (April of the following year), the total sum of $2,000 should be accounted for as rental income in the current year. 

IMPORTANT: Rental income collected in advance must be reported in the tax year it is collected, irrespective of the period it covers. This aligns with the IRS guidance on recognizing advance rent income in the year of receipt.

Bad accounting could open you up to legal issues, IRS audits, and infringe on your ability to operate a profitable rental.  

There are several ways to record and report this income. The first is with a simple hand-written ledger. This though is inefficient and error-prone and carries with it serious limitations when it comes to reporting and reviewing your financial data (especially at tax time). The second is to use a spreadsheet, which, whilst certainly better than a handwritten ledger, is still problematic, and prone to data input errors.

This is why so many real estate investors are modernizing their record-keeping with purpose-built rental property accounting and management software like Landlord Studio. 

With Landlord Studio you can automate rent and income tracking with online rent collection. The software will automatically chase up late payments, apply late fees, and even record and track your rental income for you. All you have to do is click a button at the end of the month, quarter, or year to run any of the 15+ accountant-approved reports.

Final Words

As a landlord, meticulous tracking of prepaid rent is crucial for maintaining accurate financial records and ensuring that you receive the payments owed to you.

For landlords with small to medium-sized property portfolios, it is recommended that they explore solutions like Landlord Studio to manage their income and security deposit tracking. This platform eliminates the need for manual data entry by seamlessly connecting to bank and credit card accounts, and automatically importing transactions. 

Beyond managing prepaid rent, Landlord Studio assists in overseeing rental income, operating expenses, and generating financial reports. The added convenience of collecting rent payments online enhances efficiency for landlords.

Create your free Landlord Studio account today and experience the benefits of automated record-keeping, financial tracking, and online rent payment collection without any associated costs.