How Is Rental Income Taxed?

Ines Zemelman, EA
Ines Zemelman, EA
• 23.09.21 • 5 min read
How Is Rental Income Taxed?

Does renting out properties make up part of your income? Real estate investments can generate regular income and capital growth and can also reduce your tax burden on profits by offering rental income tax deductions.

Nevertheless, it's important to consider your investing style first. Do you invest passively in real estate or do you work as a professional in the industry? You will receive different tax breaks based on whether you are classified as one or the other.

In the real estate industry, your rental losses are not passive if you spend most of your time working on real estate. You can deduct your losses on both passive and nonpassive income, so losses are fully deductible. Considering that rental income is your sideline investment, it will be considered passive. As a result, your losses may be deductible up to $25,000 against your rental income.

What Constitutes Rental Income?

According to the IRS, if you own a rental property, then you should report any rental income you received. Rental income is defined as any cash flow generated by an apartment or property, including rent payments, lease cancellation fees, security deposits, and any other cash flow.

As a part-owner of a rental property, you are accountable for your share of the income generated by your property.

How Rental Property Income Tax Works

Rentable property is defined by the IRS as a property owned by you that you rent out every year to tenants for at least 15 days. Real estate investors pay rental property income tax according to their marginal tax brackets, which is based on the rental income.

Your rental income may be taxed differently based on whether you own passive or non-passive rental properties. The income from rental properties is typically considered passive income and taxed accordingly. Rental businesses that are non-passive usually manage their property, develop it, construct it, operate it and manage it.

Rent that you earn from your rental property on your tax return is taxable as ordinary income. Suppose you have an annual gross rental income of $20,000 and expenses directly associated with renting out the property are $9,500, you end up with a net rental income of $10,500. Taxes would amount to $2,520 if you are subject to a 24% tax bracket.

How To Report Rental Income Tax

When you rent a building, an apartment, or a room, the rental income and expenditures are normally reported on Form 1040 or Form 1040-SR along with Schedule E. The Schedule E of each rental property should show the income, expenses, and depreciation for each asset. Complete as many Schedule Es as you need to list all your rental properties if you have more than three.

The loss on your rental property may be limited if your rental expenses exceed your rental income. By following the passive activity loss rules and the at-risk rules, you may be able to deduct less than the full amount of a loss.

It is crucial that real estate investors maintain expenses and income records throughout the year to ensure a smooth tax filing process. You should keep records of business receipts, rent checks, and other paperwork relating to potential rental property income tax deductions as per law. Last but not least, always carefully review the rental income information you have reported to the IRS. When it comes to filing your paperwork, it's best to be safe than sorry. 

How To Reduce Tax Bill On Rental Income 

Rental property profits from rental investments are usually quite attractive to real estate investors until the tax season arrives. Thus, it is extremely important to know which rental property income tax deductions you qualify for. You can deduct any expense from your taxable income if it qualifies as a deduction. As a consequence, deductions can result in a lower tax bill by reducing your taxable income.

Investing in real estate can generate rental income tax deductions for management, conservation, and maintenance expenses. Ordinary and necessary expenses qualify for deductions. A common expense is one that is usually associated with any sector of business activity. There are some expenses that are considered necessities, like advertising and marketing, interest, taxes, professional fees, repairs and maintenance, property tax, and utilities. 

You may be eligible to take advantage of several deductions as a property owner, including:

  • Property Depreciation has long been known as one of the most popular tax benefits available to real estate investors. You are probably aware that there are real estate investors with wealthy cash flows, yet they pay virtually no taxes on their income. This is in part due, among other reasons, to depreciation expenses incurred by income-producing properties.
  • A rental property investor can also deduct the interest on the loan. Renter's income tax is largely deductible by interest.
  • The deduction of repair and maintenance expenses is also eligible.
  • Fire, flood, theft, and liability insurance premiums related to rental activity can be deducted.
  • Attorney fees, property management fees, accountant fees, and advisor fees may be deducted under operating expenses.

There are more deductible expenses to add to this list. A tax accountant can help you discover many other aspects of your expenses that are tax-deductible. 

​​Tips On Rental Real Estate Income From The IRS

For tax reporting and maintaining records, as well as important information about deductions for rental property, please read the guides below to help you avoid mistakes. 

  • Any compensation received from renting out your property is considered rental income.
  • Rent payments, advance rent payments, and security deposits are all classified as rental income when they are used as final rent payments.
  • Besides cash rent, rental income may also come from non-cash receipts, such as work done by the tenant in exchange for free rent or utilities paid by the tenant, which would otherwise have to be borne by the landlord.
  • Landlords are also considered to have real estate income when they collect cancellation fees from tenants.
  • A rental property's management, conservation, and maintenance expenses can be written off in the same year they are spent.

Tax preparation can be a bit challenging. The help of a tax accountant could be crucial if you're a landlord who feels confused or overwhelmed, as could be the case. Tax accountants can assist you with questions about rental income and other tax matters.