Rental income is taxed as ordinary income at your regular tax rate, plus you owe self-employment tax on the net profit

The IRS treats rental income the same way it treats wages or salary — it is added to your other income and taxed at whatever bracket you fall into. If you are in the 22% federal tax bracket, rental profit is taxed at 22%. You also owe self-employment tax (Social Security and Medicare) on the net profit, which adds roughly 15.3% on top of that. State and local income tax may apply as well, depending on where you live and where the property is located.

The key word is net profit, not gross rent. You can deduct legitimate expenses — mortgage interest, property tax, repairs, insurance, utilities you pay, property management fees, advertising for tenants — which lowers the amount you actually owe tax on. Many new landlords assume they owe tax on every dollar of rent collected, then are surprised when they learn about deductions.

Key Takeaways

  • Rental profit is taxed at your ordinary income tax rate (federal, state, and local), plus self-employment tax of roughly 15.3%.
  • You only pay tax on net profit after deducting legitimate expenses like mortgage interest, repairs, insurance, and property tax.
  • You must report rental income and expenses on Schedule E (Form 1040) when you file your tax return each year.
  • Depreciation on the building itself reduces your taxable income each year, though you may owe tax on that depreciation when you sell the property.
  • Keeping detailed records of all expenses and rent received is essential — the IRS expects landlords to track this information.

What counts as rental income and what you can deduct

Rental income includes not just monthly rent but also security deposits you keep (for damage beyond normal wear), late fees, pet fees, and any other money a tenant pays you related to occupancy. If a tenant breaks the lease and you keep part of the deposit, that counts as income in the year you keep it.

Deductible expenses include mortgage interest (not principal), property tax, homeowners insurance, repairs and maintenance, utilities you pay, property management fees, advertising to find tenants, legal fees for eviction or lease disputes, HOA fees, and depreciation. You cannot deduct the cost of improvements that add value to the property (like a new roof or kitchen remodel) in the year you pay for them — those are capitalized and depreciated over many years instead. The line between repair and improvement is often unclear, which is why many landlords consult a tax professional.

How to report rental income on your tax return

You report rental income and expenses on Schedule E (Form 1040), which is part of your federal tax return. Schedule E has separate lines for income, then sections for each category of expense. You calculate your net profit or loss, and that number flows to your main tax return where it is added to your other income.

If you own multiple properties, you file a separate Schedule E for each one (or group them on the same form, depending on how you organize your records). If you have a loss in a given year — expenses exceed income — you can usually deduct that loss against other income, though there are limits if you are a passive investor rather than an active landlord.

You must keep records of all rent received and all expenses for at least three years, though the IRS can go back longer if they suspect underreporting. Bank statements, receipts, invoices, and a simple spreadsheet or ledger are sufficient — you do not need special accounting software, though many landlords use it.

Self-employment tax on rental income

If you actively manage the property yourself (rather than hiring a property manager), you owe self-employment tax on the net profit. Self-employment tax covers Social Security and Medicare and is roughly 15.3% of your net profit. You pay half of it directly and can deduct the other half as a business expense on your return.

If you hire a property manager and are truly passive — you do not make decisions about repairs, tenant selection, or rent collection — you may not owe self-employment tax. The distinction matters because it can add thousands of dollars to your annual tax bill. Many landlords with one or two properties manage them themselves and owe self-employment tax; those with larger portfolios or who hire managers may not. A tax professional can advise on your specific situation.

Depreciation and the tax benefit it creates

The building itself (not the land) can be depreciated over 27.5 years. This means you deduct a portion of the building's value each year as an expense, even though you are not actually spending money. For a $300,000 rental property where $250,000 is attributed to the building and $50,000 to the land, you would deduct roughly $9,000 per year in depreciation ($250,000 ÷ 27.5 years).

Depreciation is a powerful tax tool because it reduces your taxable income without reducing your cash flow — tenants are paying rent, but the IRS lets you deduct depreciation anyway. However, when you sell the property, the IRS recaptures that depreciation and taxes it at 25%, even if the property did not actually increase in value. If you depreciated $90,000 over ten years and then sold, you would owe tax on that $90,000 at the 25% recapture rate, regardless of your ordinary tax bracket.

State and local taxes on rental income

Most states tax rental income as ordinary income at their state rate. Some states have no income tax (Florida, Texas, Wyoming, and others), which is a significant advantage for landlords in those states. If the property is in a state with income tax but you live in a different state, you typically owe tax to the state where the property is located.

Some cities and counties also impose local income tax or rental tax. New York City, for example, taxes rental income at the city level in addition to state and federal tax. A few jurisdictions have tried vacancy taxes or other rental-specific levies. You should research the specific rules for the location of your property, as they vary widely and can meaningfully affect your after-tax return.

Estimated tax payments and avoiding penalties

If you expect to owe more than $1,000 in federal income tax for the year (including rental income tax), you are required to make estimated tax payments four times per year — roughly every three months. These are due on April 15, June 15, September 15, and January 15. If you do not make these payments and owe a large amount at tax time, you will owe a penalty on top of the tax itself.

Many landlords calculate their estimated payments based on the prior year's tax liability, which is a safe harbor — if you pay 100% of last year's tax in estimated payments this year, you generally avoid penalties even if this year's tax is higher. A tax professional or your accountant can help you calculate the correct amount and set up a system to pay on time.

Frequently Asked Questions

Do I owe tax on the security deposit when I collect it?

No, not when you collect it. A security deposit is held in trust for the tenant and is not income. You only owe tax on the portion you keep — for unpaid rent, damage beyond normal wear, or other lease violations. You report that kept amount as income in the year you keep it, not when you collected the deposit.

Can I deduct mortgage principal payments?

No. You can only deduct the interest portion of your mortgage payment, not the principal. The interest is a business expense; the principal is you paying down your own debt. Your mortgage statement shows how much of each payment is interest and how much is principal.

What if I have a loss on my rental property one year?

You can usually deduct that loss against other income on your tax return, which lowers your overall tax bill. However, if you are classified as a passive investor (you do not actively manage the property), there are limits on how much loss you can deduct in a given year. A tax professional can advise whether your situation qualifies for the active participant exception, which allows higher loss deductions.

Do I need to file a separate business tax return for my rental property?

No. Rental income is reported on Schedule E as part of your personal Form 1040 return. You do not file a separate business return unless you are operating as a corporation or partnership. A sole proprietor or single-member LLC reports rental income on Schedule E.

What happens to depreciation when I sell the property?

The IRS recaptures all depreciation you claimed and taxes it at 25%, regardless of your ordinary tax bracket or whether the property actually appreciated. If you claimed $100,000 in depreciation over ten years, you owe 25% tax on that $100,000 when you sell — roughly $25,000 — even if the property sold for less than you paid for it.