Please note: This article is not legal advice. For up-to-date information and guidance, reach out to your attorney or Real Property Associates.
It is not uncommon for investors to encounter renters at some point in their career as property owners who want to pay for your homes for rent in Seattle in advance. There could be a number of reasons for this, some of which are not always red flags:
- Your resident may want to take advantage of rental discounts
- They may have seasonal employment or contractual employment
- Your renter may understand they need a little help keeping track of finances.
If a renter requests that they pay upfront, there are a few things you and your Seattle property management company need to be aware of before you accept. Any skilled, full-service property management company should be able to go over this scenario with you to protect your interests as an investor.
Understanding Rental Prepayments
A rent prepayment is a rental payment a renter makes for future use of your property, excluding rent paid for the month following the payment. For instance, if a renter signed their lease in January and paid for six months’ rent, the first month will be the standard rent payment while the rest is a prepayment.
- Last month’s rent is also considered a form of rental prepayment.
- Asking for a renter to pay for the last month comes in handy if you are afraid that they will vacate the property without paying for the last month.
A security deposit isn't designed to cover your renter's last month in your property. Many property owners may consider this as an additional form of 'insurance.' However, as a Seattle property management company, we caution you to consider how security deposits operate under rental law.
How Is Rent Prepayment Different From a Security Deposit?
The major difference between these two payments is how each is used.
- A prepayment only covers the rent, which means that you cannot use it to repair any damages the renter causes to the property.
- On the other hand, you can use a security deposit to cover the cost of maintenance and repairs beyond typical wear and tear.
- Security deposit law can be quite serious and strict: it's best to keep rent collection and deposits separate according to whatever rental laws dictate here in the Seattle area.
The two are also treated differently when it comes to tax time. A rental prepayment is considered as income and must be reported within the year received. However, your renter’s security deposit is kept separate unless you keep all or some of it to pay for any damages. Plus, repairs are tax-deductible (up to a certain amount) for rental property owners.
When Might You Consider Prepayment?
Some of the most common reasons why you may want to consider accepting a prepayment for your rental property are:
- To ease the rent collection process: If you have not employed a Seattle property management company, you may want to ease the rent collection process by asking for upfront rent payments. That said, you'll need to work with an excellent accountant to keep track of things if you choose this method.
- If your renter has no rental history: If a renter has no history or you cannot get a recommendation from former residences, asking them for an upfront payment could be a way of ensuring that they can meet the demands of paying rent if they otherwise pass your screening process.
The Risks of Prepayment
There are certain circumstances where rental prepayments are logical. However, you need to understand the risks that may come with such an arrangement.
You Cannot Increase the Rent
When you agree to a rental prepayment, you are forfeiting your right to increase rent for the prepaid timeframe. If you intend to remodel or upgrade your rental property soon, you might want to reconsider accepting prepaid rent.
If a renter who has prepaid their rent breaks or violates the lease agreement, you will be required to refund the monies for the unutilized period if you choose to evict them. This can create some complicated situations for you as a property owner when it comes to your taxes.
It Affects Your Taxable Income
All advance rental payments are considered taxable income. As such, you will pay taxes in advance rather than during the lease period. For example, if a renter makes a rent payment for January through June in December, the advance rent paid should be claimed during the year it is paid.
Accounting and Bookkeeping
It would not be too much work to keep up with prepayments made by one or two renters. But when you are handling multiple properties without the help of a reputable Seattle property management company, it is easy to miss marking things down perfectly in your own records.
It Interferes With Any Property Resale Plans
Accepting a prepayment means that you have extended the lease term for the duration of the payments. If you had plans to renovate and sell your property, this effectively puts them on hold.
Discuss Prepayments With Your Property Manager
If a potential renter passes the screening process, talk with your Seattle property management partner about the benefits of prepaid rent. For some residents, this could be just what they need to balance their finances. That said, there are also alternatives to early payments.
- Young renters or those without a renter history could opt for a co-signer or a guarantor.
- This person is responsible for paying rent if the renter defaults.
- You could also consider taking up rent guarantee insurance.
- Such a policy will protect you against lost income if a renter defaults or falls behind on their rent payments.
- This policy also allows you sufficient time to start the legal eviction process without necessarily losing your rental income.
Advanced rental payments are just one fact of real estate investments worth considering as you grow your portfolio in the Seattle area! To learn more, download your free copy of our guide to successful real estate investing.