What counts as rental income and what doesn't

Rental income is any money you receive from a tenant in exchange for letting them live in or use your property. This includes the monthly rent payment itself, but also security deposits that you keep (not refund), late fees the tenant pays, pet fees, parking fees, and any utilities or services you provide and charge separately. It also includes rent paid by a property manager or management company on your behalf.

Money that does not count as rental income includes security deposits you hold and later return to the tenant, damage deposits you refund, or advance rent payments that cover future months — those are recorded when the rent period actually occurs, not when you receive the money. Reimbursements from tenants for repairs they caused or utilities they used also do not count as income if you are simply passing the cost through; you record only the amount above your own cost.

The distinction matters because the IRS and your state tax authority treat income and non-income differently. Keeping a security deposit counts as income in the year you keep it. Returning it does not reduce your income — you simply do not report it as income in the first place.

Key Takeaways

  • Rental income includes the monthly rent payment, any fees you keep, and deposits you do not return, but excludes security deposits you refund to the tenant.
  • You report rental income in the year you receive it or are legally may have access to to it, even if the tenant has not yet paid — this is called the accrual method and is required for most landlords.
  • Expenses you can deduct from rental income include mortgage interest (not principal), property taxes, insurance, repairs, utilities you pay, and depreciation, but not capital improvements or personal use of the property.
  • Your net rental income is the total rent and fees you receive minus all allowable expenses, and this is the figure that determines your tax liability.
  • Keeping records of every payment received and every expense paid is required by the IRS and protects you if your return is audited.

Recording rental income by the month and by the year

Most landlords and property owners are required to report rental income using the accrual method, which means you record income in the month it is earned, not the month you receive payment. If a tenant's rent is due on the first of the month but they do not pay until the fifteenth, you still record the income on the first. If they never pay at all, you still record it as income — though you can then deduct it as a bad debt loss.

To calculate your annual rental income, add up all the rent payments and fees you received or were may have access to to receive during the calendar year (January through December). If you use a different fiscal year for your business, use that year instead, but you must be consistent from year to year. Include payments received in December for January rent, but do not include January payments received in February of the following year.

Keep a simple ledger or spreadsheet with the date, tenant name, amount, and what the payment was for (rent, late fee, pet fee, and so on). This record becomes your proof if the IRS questions your return. Many landlords use accounting software like QuickBooks or FreshBooks, but a spreadsheet works just as well if you update it regularly and keep it for at least three years.

Calculating net rental income after expenses

Your net rental income is what you owe taxes on, and it is calculated by subtracting all allowable expenses from your total rental income. The IRS allows you to deduct ordinary and necessary expenses — costs you incur to earn the rental income and maintain the property.

Deductible expenses include mortgage interest (but not the principal payment), property taxes, homeowners insurance or landlord insurance, repairs and maintenance, utilities you pay on behalf of the tenant or for common areas, property management fees, advertising to find tenants, legal and accounting fees related to the rental, and depreciation of the building itself. You can also deduct a portion of your home office expenses if you use a dedicated space to manage the property.

Expenses you cannot deduct include the principal portion of your mortgage payment (that is a return of your own capital, not a business cost), capital improvements that add value to the property (like a new roof or kitchen renovation — these are depreciated over many years instead), personal use of the property, and expenses for properties you do not yet rent out. If you live in part of the building and rent out the rest, you must allocate expenses between the rental and personal portions.

To find your net income, subtract your total expenses from your total income. If expenses exceed income, you have a net loss, which you can use to offset other income on your tax return — though there are limits depending on your income level and how actively you manage the property.

Handling multiple properties and mixed-use buildings

If you own more than one rental property, calculate the income and expenses for each property separately, then add them together for your total rental income. This separation helps you see which properties are profitable and which are not, and it is required by the IRS on Schedule E (the form where rental income is reported).

If you own a building where you live in one unit and rent out others, or where part of the building is commercial and part is residential, you must split the income and expenses proportionally. If you own a four-unit building and live in one unit and rent three, you report 75 percent of the rent as income and allocate 75 percent of the expenses (property tax, insurance, utilities, repairs) to the rental business. The remaining 25 percent is personal and not deductible.

The same rule applies if you rent out a room in your home. If you rent one bedroom in a four-bedroom house, you can deduct 25 percent of utilities, property tax, insurance, and repairs, but only the expenses that benefit the whole house. You cannot deduct the cost of furnishing the rental room as a rental expense — that is a capital improvement to your home.

Depreciation and how it affects your income calculation

Depreciation is a deduction that allows you to spread the cost of the building itself over many years, even though you paid for it upfront or financed it. The IRS assumes residential rental buildings wear out over 27.5 years, so you can deduct 1/27.5th of the building's value each year. This is one of the largest deductions available to landlords, and it significantly reduces your taxable rental income.

To calculate depreciation, you need to know the value of the building only — not the land, which does not depreciate. If you bought the property for $300,000 and a professional appraisal says the land is worth $75,000, the building value is $225,000. Divide that by 27.5 to get your annual depreciation deduction of about $8,182. You claim this deduction every year you own the property, whether or not you receive any rental income that year.

Depreciation is a "paper loss" — you do not actually spend the money, but the IRS lets you deduct it anyway. However, when you sell the property, you must "recapture" the depreciation you claimed and pay tax on it at a higher rate (25 percent federal, plus state tax). This is why some landlords choose not to claim depreciation, though it is usually financially better to claim it and deal with recapture later.

Documenting and organizing your records

The IRS requires you to keep records of all rental income and expenses for at least three years, though six years is safer if you are audited. Store receipts, bank statements, lease agreements, and repair invoices in one place — either a file folder or a digital folder on your computer. Take photos of major repairs and improvements with dates.

For income, keep a record of each rent payment: the date received, the tenant's name, the amount, and which month's rent it covers. If you use online banking or a payment app like Venmo or PayPal, download and save those records. If tenants pay by check, photograph the front and back of each check before depositing it.

For expenses, keep the receipt or invoice showing the date, what was purchased or repaired, the amount paid, and the vendor's name. If you pay for something in cash, write down the date and what it was for on a receipt or in your ledger. Credit card statements alone are not enough — you need the actual receipt showing what you bought.

Many landlords find it easier to use accounting software that connects to their bank account and automatically categorizes transactions. Others use a simple spreadsheet with columns for date, description, income, and each expense category. Either way, update your records monthly so you do not fall behind.

Frequently Asked Questions

Do I report rental income if the tenant has not paid yet?

Yes, if you use the accrual method (which most landlords must). You report rent as income in the month it is due, even if the tenant has not paid. You can then deduct unpaid rent as a bad debt loss if you later determine it will not be collected. Keep documentation showing the rent was owed and your efforts to collect it.

Can I deduct the cost of furniture or appliances I provide in the rental unit?

Furniture and appliances are capital improvements, not repairs, so you cannot deduct them in the year you buy them. Instead, you depreciate them over their useful life — typically five to seven years for appliances and furniture. Keep receipts showing the purchase date and cost, and work with a tax professional to set up the depreciation schedule.

What if I rent out the property for only part of the year?

Report only the income and expenses for the months you actually rented it out. If you rented a property from June through December, report six months of rent and allocate six months of annual expenses (property tax, insurance) to the rental business. Expenses for months when the property was vacant or personal use do not count.

Do I have to report cash payments from tenants?

Yes. All rental income must be reported, whether it is paid by check, bank transfer, cash, or any other method. The IRS does not care how you were paid — only that you report it. Keep a written record of cash payments with the date, tenant name, and amount, and deposit the cash into your business bank account so there is a paper trail.

What happens if my rental expenses are more than my rental income?

You have a net loss, which you can use to reduce your taxable income from other sources like your job or investments. However, there are limits: if you have a high income, you may not be able to deduct the full loss in the current year. Work with a tax professional to understand how passive loss rules apply to your situation.