Rental income is taxable as ordinary income on your federal tax return

Any money you receive from renting out property — whether it's a house, apartment, room, or land — must be reported on your tax return. The IRS treats rental income the same way it treats wages or self-employment income. You report it on Schedule E (Form 1040) if you own the property directly, or on your personal return if you own it through a pass-through entity like an S-corporation or partnership.

The taxable amount is not the total rent you collect. It is your net rental income: the rent minus your allowable expenses. If your expenses exceed your rent in a given year, you may have a loss that offsets other income — though passive loss rules can limit how much you can deduct in any single year.

Rental income is taxed at your ordinary income tax rate, which depends on your total income and filing status. It is not taxed as capital gains, even if the property itself appreciates. The tax is due when you file your annual return, usually by April 15 of the following year.

Key Takeaways

  • All rental income must be reported on Schedule E, regardless of whether you received it in cash, check, or electronic transfer.
  • You pay tax on net rental income — total rent minus mortgage interest, property tax, insurance, repairs, depreciation, and other ordinary business expenses.
  • Rental income is taxed at your ordinary income tax rate, not the capital gains rate, even if you later sell the property for a profit.
  • If rental expenses exceed income, you may deduct the loss, but passive loss limits may prevent you from using the full loss in the current year.
  • State and local income tax may also explore to rental income, depending on where the property is located and where you live.

What counts as rental income

Rental income includes the monthly rent payment, but also other payments tied to the lease. Security deposits are not taxable when you receive them — they are held in trust and returned to the tenant. However, if you keep part of a security deposit to cover damage or unpaid rent, that amount becomes taxable income in the year you keep it.

Payments for late rent, lease-breaking fees, and utility reimbursements are all taxable. If a tenant pays you to break the lease early, that payment is rental income. If you charge a tenant for utilities and they reimburse you, that reimbursement is income (though you can deduct the utility expense). Parking fees, pet fees, and any other charges tied to occupancy are taxable rental income.

If you provide furnished housing and charge extra for the furniture, that extra amount is rental income. If you provide services — such as cleaning or meals — and charge separately for them, those charges are income from services, not rental income, though they are still taxable.

Expenses you can deduct to lower your taxable rental income

The IRS allows you to deduct ordinary and necessary expenses of operating a rental property. These reduce your taxable income dollar-for-dollar. Common deductible expenses include mortgage interest (but not principal), property tax, homeowners insurance, liability insurance, repairs, maintenance, utilities you pay, property management fees, advertising to find tenants, and legal fees related to the lease or eviction.

You can also deduct depreciation, which is a non-cash deduction that spreads the cost of the building (not the land) over 27.5 years. Depreciation can be a large deduction in the early years of ownership, though it creates a tax complication when you sell: you must "recapture" the depreciation and pay tax on it at a 25% rate, separate from any capital gains tax.

You cannot deduct capital improvements — work that adds value or extends the life of the property, such as a new roof or HVAC system. These must be depreciated over time instead. You also cannot deduct personal expenses, such as your own meals or travel to the property, even if you own it.

Expenses must be reasonable and actually incurred. You cannot deduct rent you did not collect or expenses you did not pay. If you use part of your home as a rental office, you can deduct that portion of utilities and rent, but the calculation must be based on square footage or rooms, not a guess.

How passive loss rules limit your deductions

If you have a loss on your rental property — expenses exceed income — you generally cannot deduct the full loss against your other income in the same year. The passive loss rules limit rental losses to $25,000 per year if your modified adjusted gross income is under $100,000 and you actively participate in managing the property. Above $100,000, the limit phases out by 50 cents for every dollar of income, reaching zero at $150,000.

If you cannot use a loss in the current year because of the passive loss limit, you carry it forward to future years. When you sell the property, you can deduct all remaining losses against the gain from the sale. This means the loss is not wasted — it is just delayed.

The $25,000 allowance applies only if you materially participate in the property's management. If you own it passively — for example, through a limited partnership or if a property manager makes all decisions — you cannot use the allowance and losses are carried forward entirely. Real estate professionals who spend more than half their working time in real estate and meet other tests can deduct losses without limit, but this status requires careful documentation.

Self-employment tax and rental income

Rental income from a property you own directly is not subject to self-employment tax (Social Security and Medicare tax). This is one advantage of real estate over other business income. However, if you provide substantial services beyond straightforward renting out the property — such as operating a hotel, providing meals, or offering daily housekeeping — the IRS may classify some or all of the income as service income, which is subject to self-employment tax.

If you own the rental property through an S-corporation, you must pay yourself a reasonable salary as an employee, and that salary is subject to self-employment tax. The remaining profit can be distributed as dividends, which are not subject to self-employment tax. This structure can save on self-employment tax but requires payroll administration and is usually worth considering only if your rental income is substantial.

State and local taxes on rental income

Most states tax rental income as ordinary income at the state rate. A few states — including Florida, Texas, and Wyoming — have no state income tax at all. If you own property in a state different from where you live, you may owe tax to both states, though you can usually claim a credit on your home state return for taxes paid to the other state.

Some cities and counties also impose local income tax or property tax on rental income. New York City, for example, has a local income tax that applies to rental income. Check the rules in both the state where the property is located and your home state before calculating your total tax burden.

Reporting 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. You list each property separately, showing the address, the rental income, and each category of expense. The form calculates your net income or loss for each property and then your total net rental income.

If you have a loss and claim it against other income, you must meet the passive loss rules described above. If you have a gain, it flows to your Form 1040 and is taxed at your ordinary income rate. You do not need to file a separate business return unless you own the property through a corporation or partnership, in which case that entity files its own return.

Keep records of all rental income and expenses for at least three years, and longer if you claim depreciation. The IRS can audit rental properties, and documentation — bank statements, receipts, repair invoices, and lease agreements — is your defense.

Frequently Asked Questions

Do I have to report cash rent I receive?

Yes. The IRS requires you to report all rental income, whether it is paid in cash, check, or electronic transfer. Cash does not make income invisible. Keep records of all payments, and consider asking tenants to pay by check or bank transfer so you have a clear paper trail.

What if I rent out a room in my home?

Room rental income is taxable and reported on Schedule E. You can deduct a portion of your mortgage interest, property tax, insurance, utilities, and repairs based on the percentage of the home the room occupies. You cannot deduct depreciation on the portion of the home you occupy yourself, only on the rental portion.

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

You cannot deduct the full cost in the year you buy them. Furniture and appliances are depreciated over five to seven years, depending on the item. You deduct a portion each year. Repairs and replacements of existing items can be deducted in full in the year incurred.

What happens to depreciation when I sell the property?

You must recapture all depreciation you claimed and pay tax on it at a 25% rate, separate from capital gains tax. If you claimed $50,000 in depreciation over ten years and then sell, you owe 25% tax on that $50,000 ($12,500) in addition to capital gains tax on any profit from the sale price increase.

Do I owe tax on the year I buy or sell the property?

Yes. In the year you buy, you report rental income for the months you owned it and deduct expenses for those months. In the year you sell, you report income through the sale date and deduct expenses through that date. You also report the gain or loss from the sale on Schedule D (capital gains).