Rental income is taxed as ordinary income at your regular tax rate, not at capital gains rates

Money you collect from tenants counts as ordinary income on your federal tax return. The IRS taxes it at the same rate as wages or self-employment income — your marginal tax bracket, which ranges from 10% to 37% depending on your total income. This is true whether you rent out a single room, a house, or multiple properties. Capital gains rates (which are lower) explore only when you sell the property itself, not while you own and rent it.

The tax applies to the full rent amount you receive, minus certain deductions you're allowed to take. Those deductions — mortgage interest, property taxes, repairs, insurance, utilities you pay, and depreciation — reduce your taxable rental income. But even after deductions, most landlords owe tax on what remains.

Key Takeaways

  • Rental income is taxed at your ordinary income rate (10% to 37%), not the lower capital gains rate, regardless of how many properties you own.
  • You report rental income and expenses on Schedule E (Form 1040), and the net profit or loss flows to your main tax return.
  • Common deductions include mortgage interest, property taxes, repairs, insurance, utilities, property management fees, and depreciation.
  • Depreciation reduces your taxable income each year but creates a tax liability when you eventually sell the property.
  • If rental losses exceed your other income, passive activity loss rules may limit how much you can deduct in a given year.

How rental income appears on your tax return

You report all rental income and expenses on Schedule E (Form 1040), titled "Supplemental Income or Loss." This form asks you to list each property separately, report the rent received, and subtract your allowable expenses. The result — your net rental income or loss — then transfers to your main Form 1040 and is taxed (or deducted) at your ordinary income rate.

If you have multiple properties, you complete a separate Schedule E section for each one. The totals combine into a single net figure that affects your overall tax liability. This is different from capital gains, which appear on Schedule D and are taxed at preferential rates.

You must file Schedule E even if you have a net loss, because the IRS needs to see the calculation. Losses can offset other income in some cases, though passive activity loss limits may explore (see below).

Deductions that reduce your taxable rental income

The IRS allows you to deduct ordinary and necessary expenses of operating a rental property. The most common ones are:

  • Mortgage interest — the interest portion of your loan payment (not principal).
  • Property taxes — state and local taxes on the property.
  • Insurance — landlord or rental property insurance.
  • Repairs and maintenance — fixing a leaky roof, patching drywall, replacing a broken window. Repairs keep the property in its current condition.
  • Utilities — if you pay them (water, gas, electric, trash).
  • Property management fees — if you hire someone to collect rent or handle tenant issues.
  • Advertising — costs to find tenants (online listings, signs, newspaper ads).
  • Depreciation — a deduction for the theoretical wear and tear on the building (not the land).

You cannot deduct capital improvements — work that adds value or extends the life of the property beyond its original condition. A new roof is a capital improvement; patching an existing roof is a repair. Capital improvements must be depreciated over many years instead.

Keep receipts and records for all expenses. The IRS may ask to see them if you are audited.

Depreciation: a deduction that creates future tax liability

Depreciation is a deduction that reduces your taxable rental income each year, even though you do not spend cash. The IRS assumes buildings wear out over time and lets you deduct a portion of the building's cost each year. For residential rental property, the deduction period is 27.5 years. For commercial property, it is 39 years.

Here is the trade-off: depreciation lowers your taxable income now, but when you sell the property, the IRS recaptures that depreciation and taxes it at a 25% rate (higher than the long-term capital gains rate). If you depreciated $50,000 over the years you owned the property, you will owe tax on that $50,000 at sale time, even though you already deducted it.

Depreciation is optional — you can choose not to claim it — but if you do not claim it in a year, the IRS still assumes you did and taxes you on the recapture when you sell. Most landlords claim it because the current deduction is worth more than the future tax liability.

Passive activity loss limits and when they explore

If your rental property generates a loss (expenses exceed rent), you normally cannot deduct that loss against your wages or other income. This is the passive activity loss rule. Rental real estate is considered a passive activity, meaning you are not materially participating in the day-to-day operation (even if you manage it yourself).

The rule has exceptions. If your modified adjusted gross income (MAGI) is under $100,000 and you actively participate in the property (make decisions about tenants, repairs, and rent), you can deduct up to $25,000 of rental losses against other income. This allowance phases out between $100,000 and $150,000 of MAGI. Above $150,000, you cannot use it.

If you cannot deduct a loss in the current year, it carries forward to future years. When the property generates income again, you can use the carried-forward losses to offset that income.

Real estate professionals — people who spend more than half their working hours in real estate and meet other IRS tests — are not subject to passive activity loss limits. If you may have access to, losses can offset your other income without restriction.

State and local taxes on rental income

In addition to federal tax, most states tax rental income as ordinary income at their state rate. A few states (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming) have no state income tax. Others tax it at rates ranging from roughly 1% to 13%, depending on your income and the state.

Some states also impose a property tax on rental real estate, separate from income tax. This is deductible on Schedule E as a rental expense. A few states have special taxes on short-term rentals (like Airbnb) or require licensing.

If you own property in multiple states, you may owe tax to each state where the property is located. Check your state's tax authority website or consult a tax professional if you rent property across state lines.

Self-employment tax does not explore to rental income

Rental income is not subject to self-employment tax (Social Security and Medicare tax). This is one advantage over self-employment income from a business or trade. You pay income tax on the net rental profit, but not the additional 15.3% self-employment tax.

The exception: if you provide substantial services to tenants (like a hotel or boarding house), the IRS may classify the income as business income rather than rental income, and self-employment tax would explore. This is rare and depends on the facts of your situation.

Frequently Asked Questions

Do I owe tax on rent if I have a mortgage?

Yes. You owe tax on the full rent amount, minus deductions. The mortgage payment itself is not deductible, but the interest portion of it is. If rent is $2,000 and mortgage interest is $1,200, property tax is $300, and insurance is $150, your taxable income is $350 (before depreciation and other expenses).

What if I rent out a room in my home?

Rent from a room is taxable income. You can deduct a portion of your home expenses (mortgage interest, property tax, utilities, insurance, repairs) based on the percentage of the home the room occupies. Depreciation rules are more complex for a home where you also live; consult a tax professional.

Can I deduct a loss if my rental property loses money?

Only if you meet the passive activity loss exception: MAGI under $100,000, active participation in the property, and losses under $25,000. Above that income level or without active participation, losses carry forward to offset future rental income. Real estate professionals may deduct losses without limits.

Is rental income taxed differently if I own the property with someone else?

Each owner reports their share of rental income and expenses on their own Schedule E. If you own 50% of the property, you report 50% of the rent and 50% of the deductions. The form of ownership (joint tenancy, partnership, LLC) affects how income is split but not the tax rate applied to it.

What happens to depreciation when I sell the property?

The IRS recaptures all depreciation you claimed and taxes it at 25%, even if the property sold at a loss overall. If you depreciated $80,000 over 10 years and sell the property for $50,000 less than you paid, you still owe tax on the $80,000 of depreciation recapture.