Rental Real Estate Income Tax 101

Ines Zemelman, EA
Ines Zemelman, EA
• 31.08.21 • 6 mins read
Rental Real Estate Income Tax 101

You may just have learned that acquiring a rental property might make your taxes more complicated. Landlord tax on rental income is more complicated than conventional income taxes. But, contrary to popular belief, the ramifications of landlord tax aren't as complicated as they appear.

There are two types of landlord property tax that property owners should be aware of. The first is how the IRS views the rental income generated by your property. The second is how it handles your rental property's eventual sale.

Read on to learn what rental property owners must know about rental income, the US rental income tax rate and how rental income is taxed in the US.

But first, let’s discuss what rental income is.

What Is Considered Rental Income?

You must normally include any payments received as rent in your gross income. Any payment you receive for the use or occupation of property is referred to as rental income. Rental income from all of your properties must be reported. There are additional amounts that may be rental income and must be recorded on your tax return in addition to the amounts you get as regular rent payments. Read on below to find out what they are.

  • Any payment you get before the time it covers is known as advance rent. Regardless of the time covered or the accounting technique used, include advance rent in your rental income in the year you receive it. For instance, suppose you sign a ten-year contract to rent your home. You will be paid $5,000 for the first year of rent and $5,000 for the final year of the lease. In the first year, you must include $10,000 in your income.
  • Security deposits are called advance rent when they are utilized as a final payment of rent. When you get it, include it in your income. If you plan to return a security deposit to your tenant at the end of the lease, do not count it in your income when you get it. However, if you keep a portion or all of the security deposit during a given year because your renter does not comply with the lease's requirements, you must include that amount in your income for that year.
  • If your tenant pays you to cancel a lease, you will receive payment. The money you get is for rent. Regardless of your accounting technique, include the amount in your income in the year you receive it.
  • If your tenant covers any of your expenses, you will have expenditures paid by the tenant. You must account for them as part of your rental income. If the charges are deductible rental expenditures, you can include them in the landlord tax deductions. For example, your tenant pays your rental property's water and sewage bill and deducts it from the regular rent payment. Your tenant is not obligated to pay this bill under the terms of the lease. Include the tenant's utility bill as well as any rent money you receive in your rental revenue.
  • Property or services received as rent, rather than money, must be included in your rental income as the fair market value of the property or services. If your tenant is a painter, for example, he or she offers to paint your rental home instead of paying rent for two months. If you accept the offer, deduct the amount the tenant would have paid for two months' rent from your rental income.
  • If your rental agreement includes the opportunity for your renter to purchase your rental property, you have a lease with the option to buy. The payments you earn as a result of the contract are considered to be rental income.
  • You must declare your share of the rental revenue from a rental property if you own a portion of it.

How Rental Income Tax Works

The Internal Revenue Service considers a rental property to be one that you own and rent to clients for 15 days or more each year. A single house, apartment, condominium, mobile home, vacation home, or similar dwelling is defined by the IRS as rental property. On your tax return, any net income generated by your rental property is taxable as ordinary income.

That's how the rental income tax works in a nutshell. However, you've probably heard of real estate investors who own hundreds of thousands of dollars worth of property but pay almost no taxes.

It's entirely permissible for them to do what they're doing. In fact, any rental property owner—including yourself—can own an investment property that generates consistent monthly cash flow while filing a tax return with a loss. All you have to do is adhere to the IRS's guidelines for renting out residential property.

How to Report Rental Income on Your Tax Return

You usually report your rental income and expenses on Schedule E, Part I, of Form 1040 or 1040-SR if you rent real estate such as buildings, rooms, or apartments. On the corresponding line of Schedule E, list your total income, expenditure, and depreciation for each rental property. To compute the amount of depreciation to enter on line 18, consult the Instructions for Form 4562.

Fill out and attach as many Schedules E as you need to list your rental properties if you have more than three. Fill out lines 1 and 2 for each property, making sure to include the street address. Only one Schedule E should have the "Totals" column filled in. On the Schedule E, the number in the "Totals" column should represent the sum of all Schedule E totals.

Your loss may be limited if your rental expenses are higher than your rental income. The passive activity loss guidelines and the at-risk rules may limit the amount of loss you can deduct. To see if your loss is limited, fill out Form 8582, Passive Activity Loss Limitations, and Form 6198, At-Risk Limitations.

Your rental expenses and losses may be reduced if you have any personal use of a dwelling unit that you rent (including a vacation home or a residence where you rent a room).

What Records to Keep

Quality audits will aid you in staying on top of your rental property's growth, preparing financial statements, identifying the source of receipts, keeping track of deductible expenditure, preparing tax returns, and supporting items reported on tax forms.

Maintain thorough records of your rental activity, including the rental income and expenditure. If your returns are chosen for audit, you must be able to document this information. You may be subject to additional taxes and penalties if you are audited and cannot show proof to support things reported on your tax returns.

What Are the US Tax Deductions for Rental Property?

Now that we’ve defined rental income, it’s important to mention that you don’t have to pay tax on all of the rental income you collect. Expenses associated with the property are deductible against rental income. Allowable expense deductions may include:

  • Costs of cleaning and maintaining the property
  • Mortgage interest
  • Insurance costs
  • Money you spend advertising the property
  • Payments to a property manager
  • HOA dues or condo fees
  • Property taxes
  • Services you pay for (such as utilities and pest control)
  • Legal and other professional fees related to owning the property