Start with gross rent, then subtract what you actually paid

Rental income for tax purposes is not the same as the rent your tenant pays you. The IRS wants to know your net rental income — what you collected minus the expenses you incurred to earn it. You report this on Schedule E (Form 1040), which is where the IRS expects to see all rental property activity.

The calculation is straightforward in structure: add up all rent received during the year, then subtract the operating expenses you paid. The result is your taxable rental income. The complexity comes in knowing which expenses count and which do not, and in tracking them correctly throughout the year.

Key Takeaways

  • Rental income includes not only monthly rent but also late fees, security deposits you keep, and any payments tenants make for utilities or repairs you normally cover.
  • Deductible expenses include mortgage interest (not principal), property taxes, insurance, repairs, maintenance, utilities you pay, property management fees, and depreciation.
  • Capital improvements — new roof, new HVAC system, foundation work — are depreciated over years, not deducted in full the year you pay for them.
  • You must track expenses throughout the year with receipts and invoices; waiting until tax time to reconstruct them creates gaps and invites audit risk.
  • If you have a loss after deductions, you may be able to carry it forward or use it against other income, depending on your income level and how actively you manage the property.

What counts as rental income

Rental income is broader than just the monthly rent check. It includes any payment a tenant makes to you in connection with occupying the property. Late fees, returned security deposits you keep (because of damage or unpaid rent), and payments for utilities or services you normally provide all count as rental income.

If a tenant pays you to break a lease early, that payment is rental income. If you receive a damage deposit and return part of it, only the portion you keep is income — the portion you return is not. If a tenant pays you directly for a repair instead of you billing the landlord, that is also income to you.

Rent received in the form of property, services, or other non-cash payment counts at fair market value. If a tenant paints your garage in exchange for a month's rent reduction, you report the fair market value of that painting work as rental income.

Expenses you can deduct

The IRS allows you to deduct ordinary and necessary expenses incurred to earn rental income. Mortgage interest is deductible; principal payments are not. Property taxes, homeowners insurance, liability insurance, and flood insurance are all deductible. Utilities you pay (electricity, water, gas, trash) are deductible if the tenant does not pay them directly.

Repairs and maintenance are deductible in the year you pay for them. Painting, fixing a leaky faucet, patching drywall, replacing a broken window, and unclogging a drain all count. Property management fees, if you hire someone to collect rent and handle tenant issues, are deductible. Advertising costs to find tenants, credit check fees, and legal fees related to eviction or lease disputes are deductible.

Depreciation is a deduction that does not involve cash leaving your account. You deduct a portion of the building's value each year over 27.5 years (for residential rental property). You cannot depreciate the land itself, only the structure. Depreciation is calculated on Form 4562 and carried to Schedule E. This deduction can be valuable, but it also affects your basis in the property and may trigger recapture tax when you sell.

Capital improvements versus repairs

This distinction trips up many landlords. A repair restores the property to its previous condition and is deductible in full in the year you pay for it. A capital improvement adds value, prolongs the life of the property, or adapts it to a new use, and must be depreciated over several years.

Replacing a broken window is a repair. Replacing all the windows with new energy-efficient ones is a capital improvement. Patching a roof is a repair. Replacing the entire roof is a capital improvement. Fixing a toilet is a repair. Replacing all plumbing in the house is a capital improvement. Painting interior walls is typically a repair. Adding a new room is a capital improvement.

When you are unsure, ask yourself: does this fix something that is broken, or does it make the property better than it was? If you are adding square footage, upgrading systems, or extending the useful life of a major component, it is likely a capital improvement. Keep invoices and receipts for both categories; the IRS may challenge the classification, and documentation helps you defend your position.

Tracking expenses throughout the year

Do not wait until tax time to gather receipts. Set up a straightforward system — a spreadsheet, a folder, or accounting software — and record expenses as they happen. Include the date, the vendor, the amount, and what the expense was for. Take photos of receipts and invoices, especially for large items.

Separate your rental expenses from personal expenses. If you use a credit card or bank account for both, categorize transactions as you review them each month. If you pay for something that benefits both your rental property and your personal use (such as a general contractor who does work on both), split the cost proportionally.

For mileage — driving to the property to inspect it, meet contractors, or handle maintenance — keep a log with dates, destinations, and purpose. The IRS allows a standard mileage rate for business use; for 2024 it is 67.5 cents per mile for business use, but this rate changes annually. Do not guess at mileage; the IRS scrutinizes unsupported mileage claims.

How to report rental income on your tax return

You report rental income and expenses on Schedule E (Form 1040), which is filed with your federal tax return. If you own multiple properties, you list each one separately on Schedule E. The form asks for gross rental income, then walks you through deductions line by line: advertising, auto and travel, cleaning and maintenance, commissions, insurance, mortgage interest, repairs, taxes, utilities, depreciation, and other expenses.

At the bottom of Schedule E, you arrive at your net rental income or loss. If you have a net loss, you may be able to deduct it against other income (wages, investment income) if you meet certain tests. If your modified adjusted gross income exceeds $150,000 (for 2024; this threshold changes annually), passive activity loss limitations may prevent you from using the loss in the current year. A tax professional can help you understand whether a loss carries forward or is usable now.

Keep all receipts, invoices, bank statements, and mortgage statements for at least three years. The IRS can audit back three years as a matter of course, and up to six years if it suspects underreporting of income by more than 25 percent.

When to use a spreadsheet versus accounting software

A straightforward spreadsheet works if you own one or two properties with straightforward expenses. Create columns for date, category (repairs, utilities, insurance, etc.), description, and amount. Total each category at year-end and transfer the totals to Schedule E.

Accounting software such as QuickBooks Self-Employed or Wave (free) is worth considering if you own multiple properties, have many transactions, or want to track expenses in real time. These tools categorize expenses automatically, generate reports by category, and can export data in a format that makes filling out Schedule E easier. They also flag duplicate transactions and help you spot missing receipts.

A tax professional or CPA can also handle the calculation for you, especially if your situation is complex — if you have a loss you need to evaluate for passive activity rules, if you are depreciating a building you recently purchased, or if you have had a major capital improvement. The cost of professional help often pays for itself in deductions you might otherwise miss.

Frequently Asked Questions

Do I report rent I have not collected yet?

No. The IRS uses the cash method for most rental landlords, meaning you report income when you actually receive it, not when it is due. If a tenant owes you rent for December but does not pay until January, you report it in January. If a tenant never pays, you do not report it as income. You may be able to deduct a bad debt if you used the accrual method, but most small landlords use cash.

Can I deduct the cost of a new furnace I installed?

A new furnace is a capital improvement because it replaces a major system and extends the property's useful life. You cannot deduct the full cost in the year you install it. Instead, you depreciate it over its useful life, which the IRS sets at 15 years for certain property improvements. Your tax professional can help you determine the correct depreciation period and method.

What if I live in part of the rental property?

You can only deduct expenses for the portion you rent out. If you own a duplex and live in one unit and rent the other, you deduct 50 percent of utilities, property taxes, insurance, and mortgage interest. Repairs and maintenance are deductible only for the rental unit. Depreciation applies only to the rental portion of the building.

Do I have to report security deposits as income?

No, not when you receive them. A security deposit is held in trust for the tenant. You report it as income only if you keep part or all of it — for unpaid rent, damage beyond normal wear, or cleaning costs. The portion you return to the tenant is not income.

Can I deduct losses from my rental property against my salary?

It depends. If your modified adjusted gross income is below $150,000 (for 2024) and you actively manage the property, you can deduct up to $25,000 in losses against other income. Above that threshold, losses are limited or suspended under passive activity loss rules. A tax professional can calculate your specific limit based on your income and involvement in managing the property.