Rental Property Tax: Guide for New and Experienced Landlords

Taxes aren't exactly a landlord's favorite topic, but as a wise person (probably) once said, cometh the income, cometh the IRS.

And so, here you are, figuring out rental property taxes. Kudos.

To make this thing as painless as possible, we explain everything about rental property tax, from what counts as income to deductions and depreciation to selling your property.

What Counts as Rental Income?

Apart from monthly rental payments, the Internal Revenue Service (IRS) considers a few other things as part of your taxable income, including:

• Advance rent: If your tenant pays rent ahead of time (like the last month's rent or multiple months in advance), that's income now, even if they're still living there later.

• Non-refundable fees: Cleaning fees, pet fees, and even lease cancellation fees—if the tenant pays them and they're not refundable, Uncle Sam wants a cut.

• Services in lieu of rent: Did your tenant fix the plumbing themselves instead of a rent payment? That's considered income, too, even if no cash changed hands.

What about gross and net rental income? What’s the difference, and how does it apply to rental property taxes? Gross income is the total of everything you collect. Net is what's left after deductible expenses (like repairs and property taxes). The good news? You only pay taxes on the net income.

And what about security deposits? Where do they fit in?

Security deposits are a gray area. If you plan to return the full deposit to the tenant when they move out, it's NOT considered income. But, if you keep any part of it for damages or unpaid rent, that amount becomes taxable income.

Learn more: what is a residential rental property?

How is Rental Income Taxed?

Rental income is considered ordinary income, which means it is added to your other earnings and taxed at the usual federal income tax rate—anywhere between 10% and 37%, depending on your tax bracket.

The good news? You get to deduct a bunch of expenses related to your rental property, which can significantly lower your taxable income.

Learn more: property taxes by state.

Rental Property Tax Deductions

Ah, sweet relief. Here are the rental expenses homeowners can claim:

1. Mortgage interest: The interest you pay on loans used to acquire or improve your rental property is generally deductible.

2. Property taxes: Yep, you can deduct the property taxes you pay on your rental.

3. Insurance premiums: Premiums for landlord insurance, property insurance, and liability insurance are typically deductible.

4. Repairs and maintenance: The cost of fixing up your rental, from plumbing repairs to repainting, can be deducted.

5. Depreciation: You can write off a portion of your property's value each year, even if it's appreciating.

6. Travel expenses: If you need to travel to manage your property, those costs might be deductible.

7. Professional services: Fees for property managers, accountants, and lawyers can often be deducted.

8. Utilities: If you're covering any utilities for your rental (like water or trash), those costs are deductible too.

9. Home office: If you have a dedicated space in your home used exclusively for your rental business, you can deduct a portion of your home expenses like rent, utilities, and insurance.

Learn more: investment property tax deductions for landlords.

Depreciation and Recapture for Rental Properties

Depreciation lets you deduct a portion of your property's cost each year. The IRS has a system for this called MACRS (Modified Accelerated Cost Recovery System).

It sounds complicated, but it just means there's a set timeframe over which you can claim depreciation. You divide the cost basis (your original investment minus the value of the land) by the property’s useful life (27.5 years for a residential rental property), and voilà, that's your annual depreciation deduction.

However, there's a catch: depreciation recapture. If you sell your property for more than its depreciated value, you'll have to pay taxes on some of those deductions you took. This recapture is taxed as a capital gain.

FYI: You can find detailed instructions and examples for deprecation and recapture in the IRS’s Publication 946.

Special Tax Considerations for Rental Properties

Real estate tax rules get more complicated when you throw in things like short-term rentals or if your property doubles as a vacation home. Let's break down some of these niche but common situations:

• Short-term rentals (Airbnb and the like): If you rent out a property for less than 14 days a year and the remaining time the property is empty or used for personal use, lucky you—that income is tax-free. But if you rent it out more often, it's considered business income.

• Passive activity loss rules: The passive activity rules limit how much you can deduct if your rental activity is considered “passive” (meaning you're not actively involved in managing it). But don't worry—there are exceptions for rental real estate professionals and those with lower incomes.

• Tax credits: Governments encourage certain behaviors, such as offering incentives for energy-efficient upgrades, providing affordable housing, rehabilitating historic buildings, investing in Opportunity Zones, and even hiring veterans. Check if you qualify because these tax breaks can mean serious savings.

Tax Implications of Selling Rental Properties

When you sell an investment property, you'll likely have to pay capital gains tax on any profit you make. Here are some things to consider:

• Capital gains 101: It's the difference between what you sold the property for and its “adjusted basis.” The basis includes what you originally paid, plus any improvements you made, minus any depreciation you've claimed.

• Short-term vs. long-term: Held the property for less than a year? That's a short-term gain, and it's taxed as regular income (ouch!). Hold it longer, and it's a long-term gain, taxed at a lower rate.

• Depreciation recapture: Remember that sweet depreciation deduction we talked about earlier? If you sell for a profit, some gets “recaptured” and taxed at a special rate. It's a bit of a bummer, but it's the price of those earlier tax breaks.

• Losses can help: If you sold for less than your adjusted basis, that's a capital loss. The good news is that you can use these losses to offset any gains you made on other investments, potentially reducing your overall tax liability.

This is HIGHLY simplified. Tax laws are complex, so consult a pro for your specific situation.

Learn more: calculating property value with rental income.

Essential Documentation for Rental Property Owners

Time for some tough love: record-keeping isn't just for accountants. It's your best weapon come tax time (and audit season, shudder).

Here's what to keep track of:

• Every single receipt: Big or small, it all adds up. Repairs, maintenance, supplies, and even that coffee you bought while meeting a potential tenant.

• Invoices and bills: Property taxes, insurance premiums, utility bills—keep them all organized and easily accessible.

• Lease agreements: This is the foundation of your rental business. Keep copies of all signed leases, including any addendums or modifications.

• Bank statements: These show the flow of money in and out of your rental accounts, super important for proving income and expenses.

Why bother with all this paperwork? A few reasons:

• Claim those deductions: Without proper documentation, the IRS might not let you deduct expenses, leading to a higher tax bill.

• Audit protection: If you get audited (oh, and it happens), having everything in order makes the process much smoother and less stressful.

• Peace of mind: Knowing your records are organized means you can sleep easy, even during tax season.

And how do you do all this record-keeping?

• Go digital: Cloud-based accounting software makes it easy to track expenses, generate reports, and collaborate with your CPA.

• Old-school works, too: If you're a paper-and-pen person, that's totally fine. Just make sure everything is filed neatly and labeled clearly.

• Get help: If it's all too overwhelming, consider working with a professional accountant or bookkeeper. They'll keep your finances in order and make tax time a breeze.

How to Report Rental Income and Expenses on Your Taxes

It's time to face the music—reporting rental income and operating expenses might not be as fun as collecting rent checks, but there’s no avoiding it.

Let's break down the process step-by-step:

1. Gather your documents: This is where those meticulous records you've been keeping come in handy. You'll need all your income and expense documentation for the tax year, including:

   • Rent receipts or bank statements showing rental income

   • Invoices and receipts for repairs, maintenance, insurance, and property taxes

   • Mortgage interest statements

   • Any other types of documents related to your rental property expenses

2. Grab the right forms: The IRS has specific forms for reporting rental income and expenses. You'll need:

   • Schedule E (Form 1040): This is the main form for reporting rental income and expenses. You'll list your property details, income, and deductions here.

   • Form 4562: If you claim depreciation, you'll need this form to calculate and report it.

3. Fill out Schedule E: This is where the rubber meets the road. You'll need to list all your rental income and then subtract your allowable expenses to arrive at your net rental income (or loss). Be sure to double-check your figures and make sure you're reporting all income sources.

4. Don't forget depreciation: If your property qualifies, depreciation can be a significant tax advantage. Refer to IRS Publication 527 for guidance on calculating and reporting depreciation on Form 4562.

5. File on time: Missing the tax filing deadline can lead to penalties and interest charges. So, make sure you know the due date, file your tax return on time and report income and expenses accurately.

Learn more: helpful tax tips for landlords.

How Landlords Can Optimize Their Tax Position

Something, something, death and taxes…but that doesn't mean you as a taxpayer should overpay. Instead, take proactive steps to minimize your tax burden and keep more of your rental income where it belongs: in your pocket.

Here are some key strategies to consider:

• Proactive tax planning: Don't wait until April to think about taxes. Work with a tax professional throughout the year to strategize and identify potential deductions and credits.

• Choose the right legal structure: How you own your rental property impacts your tax liability. Forming an LLC or S Corporation can offer certain tax benefits and protect you from personal liability. However, each structure has its own complexities, so it's important to consult a professional to determine the best fit for your situation.

• Retirement account advantages: Consider using a self-directed IRA or other retirement accounts to invest in real estate. These accounts offer tax-deferred growth and potential deductions, allowing you to build your rental portfolio while minimizing your tax burden.

Learn more: is rental income tax deductible?

Streamline Your Rental Property Tax Management

Taxes are just one piece of the landlord puzzle. From finding and screening tenants to handling maintenance requests and staying legally compliant, the day-to-day tasks of property ownership are overwhelming.

That's where we, Ziprent, come in—your partner in maximizing your bottom line and minimizing your stress. Our experienced property managers handle every aspect of your real estate investment, from marketing your property and collecting rent to coordinating repairs and dealing with tenant issues.

Ready to experience the benefits of stress-free property ownership? Head over to our property management services page and discover how we’ll make rental property management a cinch.

FAQs

How to calculate rental property income?

Add up all the payments received from tenants, including rent, non-refundable fees, and any other payments received for using the property. The total represents your gross rental income.

Next, subtract any allowable expenses related to your rental property, including mortgage interest, property taxes, insurance premiums, repairs and maintenance costs, depreciation, marketing expenses, utilities, and home office expenses. The result is your net rental income, which is the amount subject to taxation.

Are security deposits taxable?

Security deposits are generally not taxable if you intend to return them in full to the tenant at the end of the lease. However, if you keep any portion of the deposit to cover damages or unpaid rent, that retained amount becomes taxable income in the year it's withheld.

Can you deduct rental property losses from your taxes?

Deducting rental property losses is subject to the passive activity loss rules. These rules generally limit deductions to the amount of passive income you have. However, there are exceptions for active participants in rental activities and those with lower income levels.

What happens if I don't report rental income?

Failing to report rental income is considered tax evasion and can result in real estate investors receiving severe penalties, including fines and even criminal charges. Report all rental income accurately and on time to avoid legal and financial repercussions.