Rental income is the money your tenant pays you, minus the expenses you can deduct

The IRS treats rental income differently from wages or business profit. You report the full amount your tenant pays — the gross rental income — on your tax return. Then you subtract the costs of owning and maintaining the property. What remains is your net rental income, and that is what you owe tax on. The calculation is straightforward: gross rent minus allowable expenses equals taxable rental income.

This matters because many landlords assume they owe tax on every dollar collected. In reality, you only owe tax on what is left after legitimate property costs. A property that brings in $12,000 a year but costs $8,000 to maintain produces only $4,000 in taxable income — or possibly less if you can claim depreciation.

Key Takeaways

  • Gross rental income includes rent, parking fees, pet fees, and any other money tenants pay you for use of the property.
  • You deduct ordinary and necessary expenses: mortgage interest (not principal), property tax, insurance, repairs, utilities you pay, and management fees.
  • Depreciation lets you deduct a portion of the building's cost each year, even though you are not spending money that year.
  • You report rental income and expenses on Schedule E (Form 1040), not on your main tax return.
  • Keeping receipts and a record of what you paid for is the only way to prove deductions if the IRS questions your return.

What counts as gross rental income

Gross rental income is every payment you receive from a tenant in exchange for use of the property. This includes the monthly rent, but also parking fees, pet fees, late fees, and utility reimbursements if the lease requires the tenant to reimburse you. If you furnished the property and charged extra for that, the furniture rental is income. If a tenant paid a security deposit and you kept part of it for damage, that kept amount is income in the year you kept it.

Payments that are not income include a security deposit you return in full, or a prepaid rent that you hold and explore to future months. The key distinction: if you keep the money or it represents payment for use of the property, it is income. If you are holding it temporarily on behalf of the tenant or the government, it is not.

Report gross rental income on Schedule E, Part I, line 3. You do not reduce it by expenses first — you report the full amount, then list expenses separately.

Expenses you can deduct from rental income

The IRS allows you to deduct ordinary and necessary expenses — costs that are common in rental property ownership and directly tied to producing rental income. Mortgage interest is deductible; mortgage principal is not. Property tax is deductible. Homeowners insurance, liability insurance, and loss-of-rent insurance are all deductible. Repairs and maintenance — fixing a leaky roof, repainting, replacing a broken window — are deductible.

Utilities you pay on behalf of the property are deductible: water, sewer, trash, electricity for common areas. Property management fees, if you hire a company to collect rent and handle tenant issues, are deductible. Advertising to find tenants, background check fees, and legal fees for eviction or lease disputes are deductible. Condo fees and HOA dues are deductible. Office supplies, mileage to the property, and phone calls related to the property can be deductible, though you must track them carefully.

Expenses you cannot deduct include mortgage principal (the part that builds your equity), capital improvements (major upgrades that add value or extend the property's life), and personal expenses. Painting a bedroom is a repair; building a new bedroom is a capital improvement. Replacing a broken furnace is a repair; installing a new HVAC system is a capital improvement. Capital improvements go on your balance sheet and are recovered through depreciation over many years, not deducted all at once.

How depreciation works and why it matters

Depreciation is a deduction that does not involve spending money in the current year. The IRS assumes that buildings wear out over time, so it lets you deduct a portion of the building's cost each year. You cannot depreciate the land — only the building and its components. If you bought a rental property for $300,000 and $50,000 of that was land value, you depreciate $250,000.

Residential rental property is depreciated over 27.5 years. This means you divide the depreciable basis by 27.5 to find your annual depreciation deduction. A $250,000 building produces roughly $9,091 in depreciation per year. You deduct this amount on Schedule E even though you did not write a check. This is one reason rental properties can show a loss on paper while you are collecting rent: depreciation reduces your taxable income without reducing your cash.

Depreciation recapture is important to understand: when you sell the property, the IRS taxes you on the depreciation you claimed, at a rate of 25 percent. This is separate from capital gains tax. If you claimed $100,000 in depreciation over ten years, you owe 25 percent tax on that $100,000 when you sell, in addition to any capital gains tax on the profit itself.

The difference between cash flow and taxable income

A property can be cash-flow positive but taxable-income negative, or vice versa. If you collect $12,000 in rent and spend $7,000 on expenses and depreciation, you have $5,000 in cash. But if $3,000 of that $7,000 is depreciation (which is not a cash expense), your actual cash outflow was only $4,000. You have $8,000 in cash, but you owe tax on a $5,000 loss — because depreciation reduced your taxable income below zero.

Conversely, a property can be cash-flow negative but taxable-income positive. If you collect $12,000 in rent but spend $15,000 on expenses, you have a $3,000 cash loss. But if $5,000 of that $15,000 is a capital improvement (which you cannot deduct all at once), your deductible expenses are only $10,000. You have a $2,000 taxable loss, even though you spent $3,000 more than you collected.

This is why tracking cash separately from tax deductions matters. Your bank account and your tax return tell different stories.

How to report rental income and expenses on your tax return

Rental income and expenses are reported on Schedule E (Form 1040), Supplemental Income and Loss. This is a separate form from your main 1040 return. You list each property separately if you own more than one. Part I of Schedule E is for rental real estate; Part II is for royalties and other income.

On Schedule E, you report gross rental income on line 3, then list expenses on lines 8 through 27. These include advertising, auto and travel, cleaning and maintenance, commissions, insurance, mortgage interest, repairs, taxes, utilities, and depreciation. Depreciation goes on line 18 and is calculated on Form 4562, which you attach to your return. The form walks you through the calculation and tracks depreciation year by year.

At the bottom of Schedule E, you calculate your net rental income or loss. This number flows to your main 1040 return and affects your total taxable income. If you have a net loss, there are limits on how much you can deduct in a single year — this depends on your income level and whether you are a real estate professional. A tax professional or tax software can help you navigate these limits.

Record-keeping and documentation

The IRS does not require you to send receipts with your return, but you must keep them for at least three years in case of an audit. Keep receipts for all expenses: repair invoices, insurance bills, property tax statements, utility bills, and mortgage statements showing interest paid. Take photos of repairs before and after. Keep a mileage log if you deduct mileage to the property. Save bank statements and cancelled checks.

For depreciation, keep the original purchase documents showing the property price and the allocation between land and building. Keep Form 4562 from each year you claimed depreciation. If you made capital improvements, keep the invoices and receipts showing what was done and when.

Many landlords use a spreadsheet or rental property software to track income and expenses month by month. This makes it easier to spot missing receipts and to prepare Schedule E when tax time arrives. The IRS is more likely to accept deductions that are well-documented and organized than those that are vague or incomplete.

Frequently Asked Questions

Do I have to report rental income if I only rent out a room in my house?

Yes. Any rental income, even from a single room, must be reported on Schedule E. You can deduct a proportional share of expenses — if the room is one-fifth of the house, you deduct one-fifth of utilities, property tax, insurance, and depreciation. Keep records of the square footage and the rent you collected.

Can I deduct a loss from rental property against my regular job income?

Not always. Passive activity loss limits restrict how much rental loss you can deduct in a given year. If your income is below $100,000, you may be able to deduct up to $25,000 in losses. Above that, losses are carried forward to future years. Real estate professionals (those who spend more than half their working time in real estate) have different rules. Consult a tax professional to understand your situation.

What if I only rented the property for part of the year?

Report only the income and expenses for the months it was rented. If you rented it for six months, report six months of rent and six months of expenses. Depreciation is calculated based on the number of months it was in service. Keep a record of the exact dates the property was rented and vacant.

Is the security deposit I collected income?

Only if you keep it. A security deposit returned in full to the tenant is not income. If you keep part of it for damage or unpaid rent, the amount you keep is income in the year you keep it. Report it on Schedule E as rental income.

Can I deduct the cost of furniture I bought for the rental?

Furniture is a capital asset and is depreciated, not deducted all at once. Residential rental property furniture is typically depreciated over five to seven years using accelerated methods. Keep the receipt showing what you paid and when you bought it. Form 4562 will guide you through the calculation.