Rental income is taxed as ordinary income, but only after you subtract your expenses and depreciation. Most individual landlords report it on Schedule E. Because depreciation is a noncash deduction, many rentals produce positive cash flow and a tax loss at the same time, though the passive activity rules limit when that loss can offset your other income.
- Rental income is taxed as ordinary income after expenses and depreciation, usually on Schedule E.
- Advance rent and kept security deposits count as income; deposits you plan to return don't.
- Rental losses are generally passive, with a $25,000 allowance that phases out between $100,000 and $150,000 of MAGI.
- Real estate professionals and qualifying short-term rentals are treated differently.
What Counts as Rental Income?
Rental income includes more than monthly rent. It also includes:
- Advance rent, in the year you receive it, no matter what period it covers
- Fees a tenant pays to cancel a lease
- A security deposit you keep, or one applied as the final month's rent
- Expenses a tenant pays on your behalf, such as a repair bill they cover instead of rent
A security deposit you plan to return isn't income when you receive it.
What Can Landlords Deduct?
Ordinary and necessary expenses of the rental are deductible, including:
- Mortgage interest (not principal)
- Property taxes
- Insurance
- Repairs and maintenance
- Property management fees
- Utilities you pay
- Advertising and tenant screening
- Legal and accounting fees
- Travel to the property for rental business
- Depreciation of the building and improvements
Improvements, such as a new roof or an addition, aren't deducted all at once. They're depreciated over time. Telling a repair from an improvement is one of the most common questions landlords have, so I wrote a full guide to repairs vs. improvements.
How Does Depreciation Lower Rental Taxes?
You can deduct the cost of a residential rental building over 27.5 years, even while the property is likely going up in value. Land isn't depreciable, so part of the purchase price has to be allocated to it. Depreciation is covered in depth in the depreciation and cost segregation guide.
Can Rental Losses Offset Other Income?
Rental activities are generally passive. A passive loss can usually offset only passive income, and any unused loss carries forward until you have passive income or sell the property. There are three important exceptions:
- The $25,000 allowance. If you actively participate, for example by approving tenants and setting rent, you can deduct up to $25,000 of rental losses against other income. The allowance phases out as modified adjusted gross income rises from $100,000 to $150,000.
- Real estate professional status. If you spend more than 750 hours a year and more than half of your working time in real property businesses, and you materially participate in your rentals, the losses aren't automatically passive.
- Short-term rentals. When the average stay is seven days or less, the property isn't a "rental activity" under these rules. See the short-term rental guide.
What Records Should Landlords Keep?
Keep the closing statement from your purchase, receipts for every expense and improvement, a separate bank account for the property and a log of the time you spend on it if you might qualify for one of the exceptions above. Good records turn tax season from a project into a formality.
Common Questions
Do I have to report rental income if I only rent to family?
Yes, rent you receive is income. But if you rent below fair market value to a family member, the property may be treated as personal use, which limits your deductions to the rental income.
Is rental income subject to self-employment tax?
Generally no, for a typical long-term rental reported on Schedule E. It can be different if you provide substantial services to tenants, as some short-term rental operators do.
What if my rental shows a loss?
The loss is generally passive. You may be able to use up to $25,000 of it against other income if your income is under the phaseout range, and anything unused carries forward to future years.