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During the time you’re a landlord, you may encounter tenants who offer to pay you several months’ rent upfront. It’s certainly tempting to have tenants who will be paying rent in advance — and they may have completely legitimate reasons for wanting such an agreement. However, there’s also the chance that accepting advance payments could land you in trouble later.
Any rent payment that covers a period of time beyond the next 30 days is an advance payment. For example, paying 6 months’ rent up front would be an advance payment.
There is one type of payment tenants always need to pay upfront: the security deposit. However, you charge a security deposit to protect yourself in the case your tenant fails to pay one month, breaches the lease, or damages the unit. In addition, there are a couple of key distinctions between a security deposit and paying rent in advance.
The first difference is that you only pay income tax on a security deposit if you end up keeping some of the funds, such as to pay for damages. A second important distinction relates to how you can use the funds: advance rent is only for rent payments, whereas a security deposit can be for damages or for unpaid rent. Finally, depending on your state, you may need to pay tenants interest on advance rent, which is not the case for a security deposit. It’s important to make a note of any interest payments for your rental accounting.
There are definitely advantages to accepting rent payments in advance, particularly in certain situations.
Unemployed tenants and other people who are unable to provide proof of income still need somewhere to live. They may offer to pay rent in advance to show that they can afford the unit.
Other tenants who often struggle to find a landlord are those who have never rented before and therefore have no rental history, such as college students. An upfront payment will guarantee you receive rent for at least one extra month.
Some tenants may ask if they can pay rent in advance in exchange for a discount. You may agree to the terms if you find collecting rent particularly inconvenient.
You may decide to offer a tenant the chance to make an advance rental payment if you have a property that’s particularly popular. Tenants who agree show that they’re serious and you avoid wasting time vetting other applicants.
Before you decide if you’ll allow tenants to pay you in advance, it’s important to consider some potential risks and disadvantages to accepting rent payments upfront.
Accepting advance rent because a tenant has no proof of income could backfire later, such as if the tenant is unable to make regular rent payments. You should always check credit reports and ask for references from previous landlords to gain a better picture of potential tenants’ financial situations. The exception to this could be if a tenant proposes paying rent for a year, in which case this will cover the entire period of the lease.
Consider if it’s likely that you’ll want to increase the rent during the period your tenant is offering to pay you. As you won’t be able to increase the rent after you’ve received payment, upfront payments could mean you lose money.
A major downside of receiving advance rent is that you’ll be unable to spend the money freely since you’ll need to be able to return the funds to the tenant if you terminate the lease for any reason. If the rent for the unit is expensive or the tenant pays several months in advance, this could be a large amount to return.
You must treat advance rent as income for the year you received it, even if it covers rent for the following year. This can make your rental accounting more complicated, since it may mean your income is much higher one year than the next.
As with all financial decisions you make for your rental business, it’s crucial you research local and state laws beforehand. Some states only allow you to collect first and last months’ rent plus a security deposit; others have limitations as to how many months’ rent tenants are allowed to pay you in advance.
Whatever you decide to do, you need an effective system for managing rent payments. With Landlord Studio, you can automate rent collection, receive payments straight to your bank account, and track rent all in the same place. You’ll also help tenants pay on time and avoid needing to deal with checks or visits to the bank.
Try out our rent collection feature for yourself (along with all the other features Landlord Studio provides) with a free trial.
Laura is a freelance writer and editor who specializes in advice for small business owners. She has written extensively on all kinds of real estate topics.
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