Things You Should Know About Rental Income and Taxes

Landlords know how lucrative property management can be. It is a fast-paced industry with many moving parts, including: 

• Interviewing potential tenants

• Managing current tenants

• Maintaining property quality

Whether you manage a single property or a portfolio, every landlord should have a foundational understanding of rental income, associated taxes, and strategies to minimize your business tax burden.

In this article, we’ll dive into 6 key questions every landlord or property manager should know about rental income tax and potential tax deductions. This way, you can navigate the complex world of rental income and taxes with confidence.

Key Rental Income Tax Takeaways:

• Learn what the term "rental income" indicates

• Understand the tax obligations associated with rental income 

• Gain insights into how rental income tax is calculated and whether it's earned

• Weigh potential deductible expenses, and if state taxes apply  

1. What Is Rental Income?

Rental income is a broad term that includes four sections:

• Amounts paid to cancel a lease

• Advance rent

• Expenses paid by a tenant

• Security deposits

Money that comes from a lease cancellation is considered rental income. You need to report this for the tax year in which you received it. Advance monthly rent paid in the tax year in which it is received is also considered rental income, as well as expenses paid by tenants. However, this form of rental income may be deductible.

There are several components to security deposits:

• Security deposits that will be returned to the tenant after their lease is fulfilled do not count as rental income.

• If your tenant broke the lease early or moved out of the property early, you must include the amount of income that you kept as income for the tax year.

• If you kept part or all of the tenant's security deposit because of damaged property to make repairs, you will include the amount you kept as rental income if you deduct the cost of repairs as expenses.

• The security deposit applied to your tenant's last month of their lease is advance rent. Upon receiving the money, it can be considered rental income.

2. How Much Tax Do You Pay on Rental Income?

Whether you own or manage residential, commercial, or short-term rental properties (like those found on Airbnb), you are obligated to report rental income. Rental income is reported and taxed just like any other source of income. If your combined incomes exceed a certain amount, you could be bumped to the next tax bracket and be subject to a higher tax rate. 

The tax rate on your rental income is mainly dependent on your personal income tax bracket. Review the table below for the Internal Revenue Service's (IRS’s) marginal rate for the tax year 2025.

If you own more than three rental properties, you will file a Schedule E (Form 1040) for each property.

3. How Is Rental Income Tax Calculated?

To calculate your rental income tax, add up all the rent that you've received. Include any expenses from your property. You should also include the fair market value of any merchandise or services you received. If you are planning to return security deposits at the end of the lease, don't include that amount in your gross income total. Some rental properties do not feature a security deposit, so skip that step if your property qualifies. For example, Airbnb hosts do not typically collect a security deposit for their short-term rental properties. 

Next, add the amounts of property-related costs such as advertising, depreciation, insurance, maintenance, and taxes. Finally, subtract the expenses from your gross income. This amount is your taxable income.

There are three possible results:

• For a total greater than zero, this is the amount of your taxable rental income.

• For a total that is less than zero, this is the amount that you can deduct from other income sources, such as lost business revenue.

• A total of zero doesn't affect your income.

4. Is Rental Income Earned Income?

Exceptions to rental income being considered earned income

There are scenarios where your rental income is not considered earned income.

For instance, if you use a dwelling unit as your personal residence and rent it out for fewer than 15 days in a year, you do not have to report the rental income, and you cannot deduct any expenses as rental expenses. If the property serves both rental and personal use, expenses must be split between the two uses based on the number of days used for each purpose. Only the rental portion of allowable expenses can be deducted from your tax return. This is similar to how you file business and personal deductions separately.

Passive activity loss rules

Rental income is typically considered unearned income by tax authorities, such as the IRS. Unlike earned income, which primarily includes wages, salaries, or business income from active participation, unearned income typically includes sources from real estate, such as:

• Interest

• Dividends

• Rental income

Rental real estate losses are referred to as passive activity losses. While you wouldn't be able to deduct passive rental activity losses against active income, such as a salary, you can deduct these losses against other passive income, such as a second rental property that generates a profit. 

5. What is Tax Deductible From Rental Income?

As a landlord, you can deduct numerous expenses from your rental income to reduce your tax liability. These expenses must be ordinary, necessary, and directly related to the management, conservation, or maintenance of your rental property. Below, we've listed some common tax deductions related to rental income:

• Depreciation 

• Operating Expenses 

• Repair

• Rental Property Tax

• Mortgage Interest

Taxpayers can take advantage of several deductions to reduce their tax liability and potentially avoid paying higher taxes. Expenses such as ordinary expenses and necessary expenses can reduce your tax liability or the amount you owe in taxes. 

Ordinary expenses include everyday payments made to maintain your property. Necessary expenses include advertising, insurance, maintenance expenses, and utility costs. 

Costs of maintenance, materials, repairs, and supplies are eligible for deductibles. You can also deduct expenses paid by a tenant if they are deductible rental expenses. However, you can't deduct the cost of improvements to your rental property.

How is depreciation calculated?

Depreciation for your rental property is calculated via the following steps: 

• Determine the asset/your property's cost basis 

• Select the recovery period (typically 27.5 years for residential rental properties)

• Choose the method of depreciation (Straight-line or MACRS)

• Apply the depreciation rate 

• Calculate annual depreciation

For example, if you bought a building in January 2025 for $250,000 and placed it in service that month, that purchase price is your cost basis with a 27.5-year recovery period. Determine the annual depreciation rate (1 ÷ 27.5 = 3.636% annually) using the straight-line method for equal annual deductions, resulting in an annual depreciation of $9,090. 

6. Are state taxes applicable to rental income?

State taxes generally apply to rental income, although rules can vary significantly, including for:

• Tax rates 

• Allowable deductions 

• Passive losses (whether they follow federal tax guidelines) 

For example, because Texas doesn't have a state income tax, a landlord there wouldn't owe state income tax on the $8,000 the landlord netted that year, although other property taxes and fees may still apply. In California, by contrast, a landlord would owe state income tax on that $8,000 in net rental income. 

Some states have made changes that benefit landlords, such as Arizona, which has eliminated the Transaction Privilege Tax (TPT). Starting in January 2025, Arizona prohibits cities, towns, and other jurisdictions from taxing residential rental income for long-term stays, including:

• TPT 

• Sales 

• Gross receipts 

• Use 

• Franchise 

Staying up to date with state tax rental income rules can be difficult without 1-800Accountant's year-round tax advisory solution. 

Rental Income and Taxes FAQs

How does the IRS know if I have rental income?

The IRS has several ways to determine whether you have rental income. A few of these methods include reporting by third parties, reported income and expense discrepancies, audits and reviews, and public records. As a property owner, you need to remember that the IRS is dedicated to ensuring all taxable income is reported. It's essential to report honestly and accurately. If you're unsure about your responsibilities, don't hesitate to seek advice from a real estate professional.

Do you pay taxes on rental income?

Yes, you do pay taxes on rental income in the United States. Rental income is generally considered taxable income and needs to be reported on your federal income tax return. This includes rent payments and any advance rent, security deposits used as a final payment of rent, and expenses paid by a tenant on your behalf. However, you may also deduct rental expenses to reduce your tax liability.

What forms are used to file rental income taxes?

As a landlord or real estate investor, you may need to file several tax forms, including attaching Schedule E, which reports rental income to IRS Form 1040, U.S. Individual Income Tax Return. If you paid nonemployees $600 or more for work during the year, you will have to file IRS Form 1099-NEC, Nonemployee Compensation. There may be other forms to file, depending on the entity in which your business is formed. 

When are rental income taxes due?

If you expect to owe $1,000 or more in taxes, you will be responsible for calculating and submitting quarterly estimated taxes by April 15, June 15, September 15, and January 15 each year. You will also file an annual return, typically on April 15, and may have additional state-level obligations. Check with local and state authorities to determine when rental income taxes are due at the state and local levels. 

Do I pay taxes on rental income from another state?

You must file a tax return in the state where your property is located, even if you maintain residence in another state. You might be required to file IRS Form 1040, U.S. Individual Income Tax Return, or a similar return type. Be sure to keep up with state and local tax laws applicable to your properties.

How do I avoid paying taxes on rental income?

Various deductions are available to lessen your financial burden when filing your tax return. Ordinary and necessary expenses for maintaining your property, material costs, and expenses paid by your tenants are a few examples of deductions to potentially include on your tax return.

What happens if I don't pay taxes on my rental income?

Not claiming rental income on taxes can lead to significant consequences. Rental income is considered taxable income and must be reported on your tax return. If unreported, it can lead to penalties and interest, audits, criminal charges, liens, and levies.

How are capital gains taxes calculated when a rental property is sold?

Capital gains are based on the profits made from the sale of a property, which is the difference between the price the property was sold for and the property's adjusted basis. An adjusted basis is the original price the property was purchased for, plus any improvements, minus depreciation.

Work with a Professional

Juggling your real estate tax obligations while maintaining properties and addressing tenant requests can be difficult and time-consuming. When bandwidth is at a premium and rental tax complexity distracts from core business responsibilities, consider outsourcing to the trusted tax professionals at 1-800Accountant, America’s leading virtual accounting firm.

Whether you need business tax preparation, tax advisory, or any of our professional accounting services, we have the affordable solutions you need to ensure your rental property business remains compliant with a minimal tax liability. Schedule a quick consultation — usually 30 minutes or less—to learn more.