Rental income is taxed as ordinary income at your regular tax rate, and you report it on Schedule E of your federal tax return

The IRS treats money you collect from tenants as taxable income in the year you receive it. You do not pay a separate "rental tax"—instead, your rental income gets added to your other income (wages, self-employment, investments) and taxed at whatever bracket that total puts you in. If you collected $15,000 in rent last year and earned $50,000 in wages, the IRS sees $65,000 of taxable income.

You report this on Schedule E (Form 1040), which is the IRS form for rental real estate income and loss. You file Schedule E along with your main tax return (Form 1040 or 1040-SR). If you own rental property in more than one state, you may also file state income tax returns in those states, because most states tax rental income the same way the federal government does.

Key Takeaways

  • Rental income is taxed as ordinary income at your regular tax rate, reported on Schedule E of your federal return.
  • You can deduct operating expenses—mortgage interest, property tax, insurance, repairs, utilities you pay, and depreciation—which reduces your taxable rental income.
  • Depreciation is a deduction that lets you write off the building cost over 27.5 years, even though you are not spending cash; recapture tax applies when you sell.
  • If rental expenses exceed rental income in a year, you may carry the loss forward to future years, but passive activity loss limits cap how much you can deduct against other income.
  • You must report all rental income, including partial-year rent, security deposits held (not kept), and payments received late or in cash.

What counts as rental income you must report

Rental income includes any money a tenant pays you for the right to occupy the property. This covers monthly rent, late fees, pet fees, parking fees, and utility reimbursements if the lease requires the tenant to reimburse you. It also includes rent paid late or in cash—the year you receive it is the year you report it, not the year it was owed.

Security deposits are not rental income in the year you collect them, because they belong to the tenant until you keep them for a legitimate reason (unpaid rent, damage beyond normal wear). If you keep part of a security deposit to cover damage, that amount becomes income in the year you keep it. If you return the full deposit, it was never your income.

If a tenant breaks the lease and you keep a lease-break fee, that is rental income. If you receive a payment for something other than occupancy—say, a tenant pays you to store furniture in a garage—that is also income, though it may not be rental income (the tax treatment can differ slightly, but you still report it).

Deductions that reduce your taxable rental income

You can subtract operating expenses from your rental income to arrive at taxable profit or loss. Common deductions include mortgage interest (not principal), property tax, homeowners insurance, liability insurance, repairs and maintenance, utilities you pay, property management fees, advertising to find tenants, legal and accounting fees, and HOA fees if applicable. You can also deduct the cost of tools and equipment under $2,500 (or depreciate larger items).

You cannot deduct mortgage principal—that is a return of your own capital, not an expense. You also cannot deduct capital improvements (major upgrades like a new roof or kitchen remodel) in the year you make them; instead, you depreciate them over time. The line between a repair (deductible immediately) and an improvement (depreciated) can be blurry; generally, a repair restores something to working condition, while an improvement adds value or extends useful life.

Keep receipts and records for all deductions. The IRS does not require you to attach them to your return, but you must have them if you are audited. Spreadsheets, bank statements, credit card statements, and contractor invoices all count as documentation.

How depreciation works and what it costs you later

Depreciation is a deduction that lets you write off the cost of the building (not the land) over 27.5 years, even though you are not spending cash. If you bought a rental house for $300,000 and the land is worth $50,000, the building is worth $250,000. Divided by 27.5 years, you can deduct about $9,091 per year in depreciation, whether or not you have a mortgage or collect enough rent to cover it.

Depreciation is powerful because it can turn a cash-positive rental (you collect more rent than you spend) into a tax loss, reducing your taxable income from other sources. However, there is a cost: when you sell the property, the IRS recaptures all depreciation you claimed and taxes it at 25 percent, separate from the capital gains tax on the profit itself. If you claimed $100,000 in depreciation over 10 years and then sell, you owe 25 percent tax on that $100,000 ($25,000) in addition to capital gains tax on any increase in the property's value.

You must claim depreciation if you own rental property; you cannot choose to skip it and avoid recapture later. If you did not claim it in past years, you can file an amended return to claim it retroactively, which extends the statute of limitations for that year.

Passive activity loss limits and when losses carry forward

If your rental expenses exceed your rental income in a year, you have a rental loss. However, the IRS limits how much of that loss you can use to reduce other income (wages, investment income, etc.) through passive activity loss rules. In general, if you are not a real estate professional, you can deduct up to $25,000 of passive losses against other income per year, but only if your modified adjusted gross income is below $100,000. Above that threshold, the deduction phases out and disappears at $150,000.

If your loss exceeds the limit you can deduct in a year, the excess does not disappear—it carries forward to future years. You can use carried-forward losses in any year you have rental income, or in years when your income drops below the threshold. Real estate professionals (those who spend more than half their working time in real estate and meet other IRS tests) can deduct all passive losses without limit, but the IRS scrutinizes these claims heavily.

Losses also carry forward if you sell the property. When you sell, any unused losses from prior years can offset the gain on the sale, reducing or eliminating capital gains tax.

State and local taxes on rental income

Most states tax rental income as ordinary income at the same rate they tax wages. A few states (Florida, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming) have no state income tax at all. Others tax rental income at a different rate or have special rules for real estate investors.

You may also owe local property tax, which is not an income tax but a tax on the property itself. Property tax is deductible on your federal return (up to $10,000 per year combined with state and local income and sales taxes under the SALT cap). Some cities and counties also impose rental licensing fees or transfer taxes when you buy or sell.

If you own rental property in multiple states, you typically file a nonresident return in each state where you have property and report the rental income from that state. Your home state may also tax you on out-of-state rental income, depending on state law. A tax professional familiar with multi-state rental ownership can help you understand your obligations.

Self-employment tax and rental income

Rental income from a property you own and lease to tenants is not subject to self-employment tax (Social Security and Medicare tax). This is one of the major tax advantages of rental real estate compared to self-employment income from a business or freelance work.

However, if you provide substantial services beyond typical landlord duties—for example, you operate a furnished short-term rental with daily housekeeping, linens, and concierge services—the IRS may classify some or all of your income as business income subject to self-employment tax. The line is fact-specific and often disputed. If you operate a short-term rental (Airbnb, VRBO) or provide services beyond collecting rent, consult a tax professional about whether self-employment tax applies.

Frequently Asked Questions

Do I have to report cash rent payments?

Yes. The IRS requires you to report all rental income, regardless of how you receive it. Cash, check, Venmo, or direct deposit—all must be reported in the year you receive it. Keeping cash off the books is tax evasion and can result in penalties, interest, and criminal charges if audited.

What if I rent out a room in my home?

Room rental income is reported the same way as rental property income, on Schedule E. You can deduct a portion of home expenses (mortgage interest, property tax, insurance, utilities, repairs) based on the percentage of your home the tenant occupies. You cannot deduct depreciation on the portion of the home you rent out if you live there, because your primary residence is not depreciable.

Can I deduct losses from a rental property I just bought?

Yes, if your expenses exceed income. However, passive activity loss limits apply. If you are not a real estate professional and your income is above $100,000, you may not be able to deduct the full loss against other income in the year it occurs. Unused losses carry forward to future years or to the year you sell the property.

What happens if I convert my home to a rental?

You can depreciate the building portion of your home from the date you convert it to rental use, based on its fair market value on the conversion date (not what you paid for it). You cannot depreciate the years you lived there. When you sell, you owe capital gains tax on appreciation after the conversion date, and recapture tax on depreciation claimed.

Do I report rental income if I use a property management company?

Yes. The property management company collects rent on your behalf, but it is still your income. You report the full rental income on Schedule E and deduct the management fee as an operating expense. The property manager may send you a summary of collections and expenses, which helps you complete Schedule E accurately.