A tenant pays you to cancel the lease: is it taxable income?
Yes. Publication 527 says that if your tenant pays you to cancel a lease, the amount you receive is rent, and you include it in income in the year you receive it. Record it as rental income, separate from the security deposit, which stays a liability until you apply or return it.
The tax rule
In its section on canceling a lease, Publication 527 says the amount a tenant pays you to cancel is rent. It is reported in the year received, on Schedule E line 3 with the rest of the rent, no matter what period the lease covered. A cash basis landlord counts it when it arrives.
Termination fee, deposit and leftover rent are three different things
| Money | What it is | How to record |
|---|---|---|
| Lease termination fee | Rent | Income when received |
| Security deposit | A liability you may have to return | Deposit liability, not income |
| Rent owed through the move-out date | Ordinary rent | Income when paid (or accrued if you use accrual) |
Do not net a termination fee against the deposit in your head. If you decide to keep some of the deposit for the fee or for unpaid rent, record that as its own step: reduce the deposit liability and recognize income. The same steps are in our guide to security deposit accounting.
Example a made-up tenant with a $1,500 deposit and $1,500 monthly rent agrees to leave 4 months early for a $1,500 termination fee. The tenant pays the fee and rent through move-out. Income for the fee is $1,500. The $1,500 deposit stays a liability until damage and the final accounting are done, and then it is returned or applied.
Put the agreement in writing
- The move-out date and the amount, signed by both sides.
- That the termination fee is separate from the deposit.
- Whether the tenant still owes rent through the move-out date.
- That the unit is released from the lease on payment.
Some states limit what a landlord may charge for early termination and require the landlord to try to re-rent the unit, so check your state before you set a fee.
Timing and the partial months
A cash basis landlord counts the fee in the year it arrives. If a tenant agrees in December and pays in January, it is next year's income. An accrual basis landlord follows a different rule, so ask your preparer which method your books use. Most small owners use cash.
- If the fee is paid in installments, each installment is income when received.
- If you keep the deposit instead of collecting a fee, that part of the deposit becomes income when you apply it.
- Rent for a partial last month is ordinary rent. Prorate it from the lease terms.
- If you waive the fee in exchange for the tenant leaving clean and on time, record nothing for the waived amount.
Keep the signed agreement with the ledger. If the tenant disputes the amount later, the document and the ledger show what was agreed and what was paid. Also check whether your state requires you to try to re-rent the unit, since that can affect what you may charge.
Questions to bring to your tax preparer
- Do my books use the cash method, so the fee counts in the year it arrives?
- How should I report a fee I took out of the deposit?
- Is a waived fee ever income?
- Does my state limit what I can charge for an early exit, and does it require me to re-rent first?
How DoorKeeping handles it
DoorKeeping lets you add a one time charge to a tenant's ledger and matches the tenant's payment from your bank feed, while deposits are tracked on their own. DoorKeeping gives no tax advice. Your tax preparer decides how a rule applies to you, and your state may add its own rules.
Sources
- IRS, Publication 527, Residential Rental Property, read Oct 30, 2026
- IRS, Topic no. 414, Rental income and expenses, read Oct 30, 2026
Questions
- Is a lease cancellation fee reported as rent?
- Yes. Publication 527 says the amount a tenant pays to cancel a lease is rent, reported in the year received.
- Is the security deposit part of the termination fee?
- Not unless you apply part of the deposit to it. A deposit is a liability until you keep or return it.
- Does a cancellation payment go on the same Schedule E line as normal rent?
- Yes, line 3, rents received.