Start with gross rent, then subtract what you actually paid

Rental income for tax purposes is not the rent your tenant pays you. It is the rent minus the expenses you paid to earn it. The IRS wants to know your net rental income — what is left after you account for mortgage interest, property tax, repairs, insurance, utilities you covered, and other costs tied directly to the property.

The calculation is straightforward: add up every dollar of rent (and rent-like payments) you received, then subtract every legitimate expense. The difference is what you report on Schedule E of your tax return. If expenses exceed rent in a year, you may have a rental loss, which can offset other income under certain rules.

The key decision is what counts as an expense. The IRS allows you to deduct costs that are ordinary and necessary to operate the rental — but not capital improvements that add value to the property itself. A new roof is capital; roof repairs are deductible. New kitchen cabinets are capital; fixing a broken cabinet hinge is deductible.

Key Takeaways

  • Rental income includes not just monthly rent but also security deposits you keep, late fees, pet fees, and any other payments tied to occupancy.
  • Deductible expenses include mortgage interest (not principal), property tax, insurance, repairs, utilities, advertising, property management fees, and depreciation.
  • Capital improvements — new roof, new HVAC system, kitchen remodel — are not deducted in the year you pay for them; instead, you depreciate them over many years.
  • You must track expenses with receipts and keep records for at least three years, because the IRS can audit rental returns up to six years back if income is underreported.
  • If you have a loss, passive activity rules may limit how much you can deduct against your salary or other active income in the current year.

What counts as rental income

Rental income is broader than the monthly rent check. It includes any payment your tenant makes in connection with occupying the property. This means:

  • Monthly rent
  • Security deposits you do not return (because of damage or lease violation)
  • Late fees and returned-check fees
  • Pet fees or pet rent
  • Parking fees if charged separately
  • Utilities you bill back to the tenant
  • Lease-breaking fees
  • Any other tenant-paid amount tied to use of the property

Security deposits you hold and return to the tenant are not income — you are holding the money on their behalf. But if you keep part of a deposit because of damage, that amount is rental income in the year you keep it. If you return the deposit in full, you report nothing.

If a tenant pays rent in advance — say, three months upfront — you report all of it as income in the year you receive it, even if it covers months in the next year. The IRS uses the cash method for most rental properties, meaning you report income when you receive it, not when it is earned.

Expenses you can deduct

An expense is deductible if it is ordinary (common in rental property management) and necessary (helpful to earning rental income). You can deduct these in the year you pay them:

  • Mortgage interest — but not principal payments, which reduce your loan balance and are not deductible
  • Property tax — state and local taxes on the rental property
  • Insurance — landlord or rental property insurance
  • Repairs — fixing a leaky faucet, patching drywall, replacing a broken window, repainting walls
  • Maintenance — lawn care, snow removal, gutter cleaning, pest control
  • Utilities — if you pay them and the tenant does not reimburse you
  • Advertising — online listing fees, newspaper ads, realtor commissions to find tenants
  • Property management fees — if you hire a company to collect rent and handle maintenance
  • Homeowners association dues — if the property is in an HOA
  • Office supplies and software — rent-tracking apps, accounting software, printer ink for lease documents
  • Travel — mileage to the property for repairs or inspections (at the IRS standard mileage rate), or flights to manage a distant property
  • Professional fees — accountant, tax preparer, lawyer for lease disputes

Keep receipts and invoices for all of these. The IRS does not require you to submit them with your return, but you must have them if you are audited. A credit card statement alone is not enough — you need the actual receipt showing what you bought.

Capital improvements versus repairs

This is where many landlords make mistakes. A repair fixes something that is broken or worn. A capital improvement adds value, prolongs the property's life, or adapts it to a new use. Only repairs are deductible in the year you pay for them.

A capital improvement is depreciated — you deduct a portion of its cost each year over a set period. A new roof is depreciated over 27.5 years for residential property. A new HVAC system is depreciated over 15 years. A kitchen remodel is depreciated over 27.5 years. You cannot deduct the full cost in year one.

The line between the two is not always clear. Replacing a few shingles is a repair. Replacing the entire roof is capital. Fixing a broken cabinet is a repair. Replacing all the cabinets is capital. If you are unsure, ask your tax preparer before you pay, because the decision affects when you get the deduction.

One exception: if you spend less than a certain threshold on an item (the IRS allows up to $2,500 per item in many cases, though this varies), you can deduct it as a repair even if it might technically be capital. Keep documentation of the amount you spent.

Depreciation and cost basis

When you buy a rental property, you split the purchase price into land and building. You can depreciate the building (and certain improvements) but not the land, because land does not wear out. For residential rental property, you depreciate the building portion over 27.5 years.

If you bought the property for $300,000 and the land is worth $75,000, your depreciable basis is $225,000. You divide that by 27.5 to get your annual depreciation deduction: about $8,182 per year. You claim this on Schedule E even though you did not write a check — it is a non-cash deduction.

Depreciation reduces your taxable rental income each year, which lowers your tax bill. But it also reduces your cost basis in the property. When you sell, you will owe tax on the gain at a higher rate (25% instead of 15% or 20%) to recapture the depreciation you claimed. This is called depreciation recapture. Plan for it when you think about selling.

Tracking expenses and organizing records

The IRS can audit a rental return up to three years back as a matter of routine, or up to six years back if it suspects underreported income. You need to keep records for at least three years, though six is safer. Organize by category: mortgage statements, property tax bills, insurance invoices, repair receipts, utility bills, and so on.

A spreadsheet or rental accounting app works well. Record the date, description, category, and amount for each expense. Take photos of receipts and store them digitally. If you use a credit card or bank account for rental expenses only, your statements become a backup record.

At year-end, total each category and enter the amounts on Schedule E. Your tax preparer will use these totals to calculate your net rental income. If you are audited, you will need to show the receipts that back up each category total.

How passive activity loss rules affect your deduction

If your rental expenses exceed your rental income, you have a rental loss. In most cases, you cannot deduct this loss against your salary or other active income — it is limited by passive activity loss rules. The loss carries forward to future years and can offset rental income then, or it can be deducted when you sell the property.

There is one major exception: if your modified adjusted gross income is under $100,000 and you actively participate in managing the property (you make decisions about repairs, tenants, and rent, even if a property manager handles day-to-day work), you can deduct up to $25,000 of rental losses against active income. This deduction phases out between $100,000 and $150,000 of income.

If you are a real estate professional — you spend more than half your working hours in real estate and more than 750 hours per year — passive activity rules do not explore to you at all. Your rental losses are fully deductible. This is a complex status to claim, and you should discuss it with a tax professional if you think you may have access to.

Frequently Asked Questions

Do I report rental income if I rent out a room in my home?

Yes. Rent from a room in your primary residence is taxable rental income. You can deduct a portion of your mortgage interest, property tax, insurance, utilities, and repairs — the portion that corresponds to the rented space. If the room is 20% of your home, you deduct 20% of these expenses. You cannot deduct depreciation on your primary residence, even the rented portion.

What if my tenant pays me in cash?

You must report it as income. The IRS expects you to report all rental income, regardless of how you receive it. Keep a record of cash payments — a receipt book, a log, or a bank deposit slip showing the amount and date. Depositing cash into your bank account creates a paper trail that helps if you are audited.

Can I deduct the cost of furniture or appliances I provide?

Appliances built into the property (oven, dishwasher, refrigerator) are part of the building and are depreciated over 27.5 years. Portable furniture and appliances you provide are depreciated over five or seven years, depending on the item. You cannot deduct the full cost in the year you buy them. Consult your tax preparer about the correct depreciation period for each item.

What if I have a loss because expenses are high?

The loss is subject to passive activity rules. If you actively participate in managing the property and your income is below $100,000, you can deduct up to $25,000 of the loss against your other income. Any loss above that carries forward to future years. If your income exceeds $150,000, the loss carries forward entirely and cannot offset active income until you sell the property.

Do I need to report rental income if I only rented the property for part of the year?

Yes. Report the rent you received for the months you rented it out. You can deduct expenses for those months only. If you rented it January through June and left it vacant July through December, you report six months of rent and deduct six months of expenses (mortgage interest, property tax, insurance, and so on).