Ah, rental income—that sweet cash flow that makes being a landlord all worth it.
Unfortunately, though, Uncle Sammy’s gonna want a cut.
You see, rental income is subject to federal and state income tax rates—such a bummer.
The good news? With the right know-how, you can maximize your rental property profits and keep your tax liability to a minimum.
Allow us to show you how.
What is Rental Income?
Rental income is any payment you receive for the use or occupation of your property. It includes the usual suspects, like:
Rent payments are regular payments from your tenants, whether monthly, weekly, or even daily.
Advance rent is any rent paid before the period it covers and is also considered rental income.
The unexpected extras:
Security deposits that are non-refundable (like if they were used for last month's rent or cleaning fees) are considered rental income.
Lease cancellation payments. If a tenant breaks their lease early and pays you a fee, that's rental income, too.
Oh, and don’t forget these:
Property or service payments. If a tenant pays for repairs or gives you property instead of cash for rent, the fair market value of that service or property counts as rental income.
Expenses paid by tenants on your behalf (like utilities or property taxes), those amounts are considered rental income.
Bartered goods and services paid as rent also count as rental income.
Additional charges like late fees, pet fees, and parking fees are all taxable rental income.
Is Rental Income Taxable?
Yes, like ordinary income, the IRS considers rental income to be taxable income. This means it's subject to federal income tax, and depending on where your property is located, you might also need to comply with state or even local tax laws when reporting your income.
Here's the silver lining: there are some exceptions to this rule.
For example, if you rent out your vacation home for a few weeks out of the year, but it's primarily for your own personal use, you might not have to pay taxes on that rental income. However, depending on where the property is located, there are specific rules and limitations for these exceptions, so do your research.
Learn more: Helpful tax tips for landlords.
At What Rate is Rental Income Taxed?
Rental income is subject to both federal and state income taxes. The exact rate you'll pay depends on your total income and which state your property is located in.
The federal tax system uses a progressive tax structure, which means the more you earn, the higher your tax rate. So, if your rental income (plus any other income you have) pushes you into a higher tax bracket, you'll pay a higher percentage on that income.
We’ll show you how this looks in the next section. If you want to know the exact tax rates, click here for the federal tax brackets or click here for state tax brackets.
How to Calculate Your Rental Income
Rental income is calculated by:
Determining gross rental income: The total amount of rent you collected for the tax year.
Subtracting any income losses: For operating expenses like vacant units or property manager fees, deduct the amount of rent you lost.
Calculating your net rental income: This is your gross rental income minus expenses.
Adding any other rental income: Include any other taxable rental income, like late fees or pet fees.
So, what does this look like in reality?
Let's say you’re a property owner who owns a duplex and charges $2,000 per month in rent for each unit. Your gross annual rental income would be $48,000 ($2,000 x 2 units x 12 months). But one of your units was vacant for two months, so you lost $4,000 in rent. And you paid a property manager 10% of your collected rent, so your net rental income would be:
$48,000 (gross income) - $4,000 (vacancy) - $4,400 (management fees) = $39,600
Now, let’s say you earn $75,000 from your day-to-day. $75,000 + $39,600 is a total taxable income of $114,600, and for the sake of argument, you live in New Jersey.
Here's how your federal and state tax liability would look if this were the case:
According to the federal tax brackets:
The first $11,000 is taxed at 10% = $1,100
The portion from $11,001 to $44,725 is taxed at 12% = $4,047
The portion from $44,726 to $95,375 is taxed at 22% = $11,163.78
The portion from $95,376 to $114,600 is taxed at 24% = $3,593.22
Total federal tax = $1,100 + $4,047 + $11,163.78 + $3,593.22 = $20,904
New Jersey uses a progressive income tax system. Based on a total taxable income of $114,600:
1.4% on the first $20,000 = $280
1.75% on the portion from $20,001 to $35,000 = $262.50
3.5% on the portion from $35,001 to $40,000 = $175
5.525% on the portion from $40,001 to $75,000 = $1,943.75
6.37% on the portion from $75,001 to $114,600 = $2,512.52
Total State Tax = $280 + $262.50 + $175 + $1,943.75 + $2,512.52 = $5,173.77
This scenario would give you a combined tax liability of:
Federal Taxes: $20,904
State Taxes (New Jersey): $5,173.77
Total Tax Liability: $20,904 + $5,173.77 = $26,077.77
Learn more: rental property tax guide.
What Expenses Can Be Deducted From Rental Income?
Here are some of the most common rental property tax deductions:
Mortgage interest: That chunk of your mortgage payment that goes towards interest? Deductible!
Property taxes: Those pesky property taxes? Yep, you can deduct those too.
Repairs and maintenance costs: Did you fix a leaky faucet or replace a broken window? Those repair costs are deductible.
Insurance: Your landlord insurance premiums? Deductible!
Utilities: If you pay for any utilities on the property, like water or trash, those are deductible as well.
And there's more: You can also deduct things like professional fees, travel expenses related to your rental property, and even record-keeping.
Learn more: Is rental property tax deductible?
How to Deduct Depreciation
The IRS allows you to deduct a portion of your property's value each year to account for this wear and tear. To do this, the IRS uses a system called the Modified Accelerated Cost Recovery System (MACRS).
Here's a simplified example:
Let's say your rental property is worth $300,000 (excluding the land value). The IRS might allow you to depreciate it over 27.5 years. So, each year, you could deduct about $10,909 ($300,000 / 27.5) from your rental income. This is treated as a deductible rental expense and lowers your taxable income. Nice!
For more information on MACRS, head over to Publication 946 on the IRS’s website.
How to Calculate the Qualified Business Income Deduction
Another tax benefit that might apply to you? The Qualified Business Income Deduction (QBI). It allows eligible taxpayers to deduct up to 20% of their qualified business income from taxable income (and yes, your rental property could count as a business).
However, there are a few hoops to jump through to qualify for this deduction:
Rental activities must be conducted regularly and continuously, indicating you’re doing more than just accumulating investment properties. Factors include the type of property, number of properties rented, owner's involvement, services provided, and lease terms.
The IRS offers a safe harbor under Revenue Procedure 2019-38, allowing certain rental real estate enterprises to be treated as a trade or business for QBI purposes.
Your taxable income needs to be below a certain threshold. (For 2024, that's $191,950 for single filers and $383,900 for married couples filing jointly.)
How do you calculate it?
Step 1: Calculate your QBI (rental income minus deductions).
Step 2: Multiply your QBI by 20% (QBI × 0.20).
Step 3: Compare that amount to 20% of your taxable income.
Step 4: The smaller of those two numbers is your QBI deduction.
Learn more: Investment property tax deductions for landlords.
How to Report Your Rental Income On a Tax Return
When it comes to rental income, the star of the show is Schedule E. Here's a quick rundown of how to fill out Schedule E:
Property Information: Start by providing some basic info about your property, like the address and type of rental.
Report income: This is where you'll list all that lovely rental income we talked about earlier.
Expenses: Now, it's time to deduct those expenses! List all those eligible deductions, like mortgage interest, property taxes, and repairs.
Calculate Your Net Income or Loss: Subtract your expenses from your income to determine your net rental property income (or loss if those expenses were higher than your income).
Once you've completed Schedule E, you'll transfer that information to your main income tax return (Form 1040).
Special Tax Considerations for Real Estate Professionals
Did you know that there's a special tax classification for real estate professionals? But before you start polishing your acceptance speech, let's break down what it means to be a real estate professional in the eyes of the IRS:
Time commitment: You need to spend a significant amount of time (more than 750 hours per year) on real estate activities.
Active participation: You can't just be a passive investor; you need to be actively involved in the real estate business. Think hands-on management, not just collecting rent checks.
So, what's the big deal about being a real estate professional? It comes with some sweet real estate tax advantages:
Deductible losses: If your rental properties happen to lose money, you can deduct those losses against your other income.
No passive activity loss limitations: Normally, there are limits on how much you can deduct in passive activity losses (like those from rental properties). But if you're a real estate professional, those limitations don't apply.
3.8% NIIT Exemption: For taxpayers above specific income thresholds, qualifying as a real estate professional may exempt your rental income from this additional tax of 3.8%, resulting in further tax savings.
Tax Treatment for Different Rental Arrangements
Did you know that the tax treatment of your rental income can vary depending on what kind of property you're renting out? Here's what you need to know:
Long-term residential rental properties: This is your classic rental scenario—leasing out a house or apartment to tenants for a year or more. The good news is that these types of rentals generally have the most favorable tax treatment, with plenty of deductions available.
Short-term vacation rentals: Renting out your beach condo or mountain cabin for those weekend getaways? Those are considered short-term rentals, and the tax rules can be a bit trickier. You might have to pay different taxes or face limitations on deductions.
Commercial properties: Renting out office space, retail stores, or industrial warehouses? The tax rules for these properties can be quite different, with different depreciation schedules and deduction limits.
Learn more: What is a rental property?
How to Minimize Rental Income Tax
Here are five tax-saving tips for landlords:
Maximize those deductions: Remember all those deductible expenses we talked about earlier? Don't miss out on a single one. Keep meticulous records and claim every deduction you're entitled to.
Depreciate like a pro: Depreciation can seriously reduce your taxable income over time. Make sure you're taking full advantage of this valuable deduction.
Consider a tax-deferred account: If you're saving for retirement, consider stashing some of your rental income in a tax-deferred account, like a traditional IRA or 401(k). It’ll help you lower your taxable income now and enjoy tax-free growth for the future.
Think about forming an LLC: Creating a Limited Liability Company (LLC) for your rental property can offer some tax advantages and liability protection.
Consult with a tax professional: A tax professional (like a CPA or Enrolled Agent) will help you navigate those complex rules, maximize your deductions, and minimize your tax liability.
Take Control of Your Rental Income Tax Obligations
Between finding tenants, handling maintenance, and keeping up with shifting regulations, who has time for taxes?
That's where property management comes in. A good property manager (like us) will take care of those day-to-day tasks, freeing up your time and mental energy to focus on the fun stuff… yup, taxes.
The best part? Our services are totally tax deductible, so you can enjoy hassle-free property management and reduce that tax bill at the end of the financial year.
So, if you're ready to take control of your rental property and experience the joys of stress-free ownership, jump over to our property management service page.