Rental income is the money a tenant pays you each month, minus expenses you can deduct

Gross rental income is the total rent your tenant pays. Net rental income is what remains after you subtract operating expenses — mortgage interest, property tax, insurance, repairs, maintenance, utilities you cover, and vacancy periods when the unit sits empty. Lenders, tax authorities, and housing programs all use net income when they assess your finances, so the number that matters depends on what you are trying to find out.

If you are applying for a mortgage or a home equity line of credit, the lender will calculate net income themselves using their own rules. If you are filing taxes, the IRS has specific rules about what you can and cannot deduct. If you are trying to understand what your property actually generates for you personally, you need to track both gross and net, because the gap between them is often larger than landlords expect.

Key Takeaways

  • Gross rental income is the full monthly rent; net income is what remains after you subtract mortgage interest, property tax, insurance, repairs, maintenance, and vacancy losses.
  • Mortgage principal payments do not count as an expense for income calculation, even though they reduce your net worth.
  • Lenders use their own formulas to calculate net income from your tax returns, so you cannot simply tell them a number — they verify it themselves.
  • The IRS allows you to deduct operating expenses but not capital improvements, and the distinction matters for your tax bill.
  • Vacancy and turnover costs are real expenses that reduce income, and ignoring them leads to overestimating what the property generates.

The difference between gross income and net income

Gross rental income is straightforward: it is the rent amount in your lease, multiplied by 12 months, assuming full occupancy. If your lease says $1,500 per month, gross income is $18,000 per year. That number does not change based on your expenses.

Net income subtracts what it costs to own and operate the property. Those costs include mortgage interest (not principal), property tax, homeowners insurance, maintenance and repairs, utilities you pay, property management fees if you use one, and vacancy periods when no tenant is paying. If your gross income is $18,000 and your annual expenses total $8,000, your net income is $10,000. That $10,000 is what you keep before income tax.

The reason this matters: a property that looks profitable on gross income alone may not be. A $1,500 monthly rent sounds good until you account for a $900 mortgage payment, $200 property tax, $100 insurance, $150 in maintenance reserves, and one month of vacancy per year. Suddenly that $18,000 gross becomes roughly $6,000 net — a very different picture.

What counts as a deductible expense

The IRS divides property costs into two categories: operating expenses, which you can deduct each year, and capital improvements, which you depreciate over many years. Understanding the difference affects both your taxes and how lenders see your income.

Operating expenses you can deduct include mortgage interest (but not principal), property tax, insurance premiums, repairs that restore the property to its current condition, maintenance like lawn care or gutter cleaning, utilities you pay, property management fees, advertising to find tenants, and legal fees related to the lease. You can also deduct a portion of your home office if you use it to manage the property.

Capital improvements — new roof, new HVAC system, new flooring, kitchen renovation — cannot be deducted in full the year you pay for them. Instead, you depreciate them over their useful life, usually 27.5 years for residential rental property. A $10,000 roof replacement reduces your deduction by roughly $364 per year for 27.5 years, not $10,000 in year one. This is why a year with major repairs looks different from a year with major capital work.

Mortgage principal is neither an operating expense nor a capital improvement. You cannot deduct it, but it does reduce your actual cash outflow and builds equity. This is why net income on paper can look different from cash in your pocket.

How to account for vacancy and turnover

Most landlords calculate income assuming 100 percent occupancy — the tenant pays every month for 12 months. In reality, tenants move out, units need cleaning and repairs between tenants, and there are gaps when the unit is empty. This is called vacancy loss, and it is a real expense.

Industry estimates for vacancy loss range from 5 to 10 percent of gross income, depending on your market, the condition of the property, and how quickly you can re-rent. A property in a tight market with low turnover might see 3 percent vacancy. A property in a soft market or one that turns over frequently might see 15 percent. The only honest approach is to look at your own history: if you had a tenant move out in January and the unit sat empty until March, that is two months of lost rent plus turnover costs.

Turnover costs include cleaning, repairs between tenants, painting, advertising the vacancy, and the time you spend showing the unit. These can easily run $500 to $2,000 per turnover depending on the property and market. If you turn over the unit once per year, that is a real cost that reduces net income.

How lenders calculate rental income

When you apply for a mortgage or a line of credit, the lender does not take your word for what the property generates. They pull your tax returns and use their own formula to calculate net income. Most lenders use one of two methods.

The first method is to take your Schedule E (the IRS form for rental income and loss) and use the net income or loss you reported. If you reported $10,000 in net rental income, that is the number they use. If you reported a loss, they may not count the property as generating income at all, or they may use a percentage of the gross rent instead.

The second method is to take the actual rent the tenant pays (from the lease) and apply the lender's own expense ratio. Many lenders assume expenses are 25 to 35 percent of gross income, regardless of what you actually spend. So if the lease shows $1,500 per month ($18,000 gross), the lender might calculate net income as $18,000 minus 30 percent ($5,400), leaving $12,600. This is why your actual expenses matter less to a lender than the rent amount and your tax return.

Some lenders will also reduce the income if the property is not yet rented, or if you have owned it for less than two years. They want to see a history of actual rent collection, not a promise of what the rent will be.

Documenting income for tax purposes

The IRS requires you to report all rental income on Schedule E of your tax return. You list the gross rent received, then subtract operating expenses line by line. The result is your net rental income or loss for that year.

To support this, keep records of the lease showing the rent amount, bank statements showing deposits from the tenant, receipts for all expenses you deduct, and documentation of any vacancy periods. If you claim a loss, the IRS may scrutinize whether you are running the property as a business or as a hobby, because hobby losses have different rules.

If you have a mortgage on the property, the lender will send you a Form 1098 showing the interest you paid that year. You use this to verify your mortgage interest deduction. Keep all property tax bills, insurance statements, and repair invoices for at least three years.

How to calculate rental income for housing programs

If you are applying for a housing program — such as a subsidy, a rent-controlled unit, or public housing — the program will have its own definition of rental income. Some programs count only the tenant's portion of rent and ignore your expenses entirely. Others count gross income. A few count net income.

Most housing programs define rental income as the actual rent paid by the tenant, without deductions. If the lease is $1,500 per month, that is $18,000 per year in rental income for program purposes, even if your expenses are $8,000. This is different from how a lender or the IRS treats it, so always ask the program what they mean by "rental income" before you report a number.

Some programs also have limits on how much rental income you can have and still be may be able to access. If you exceed the limit, you may lose the subsidy or be ineligible for the program. In those cases, understanding exactly how the program counts income is critical.

Frequently Asked Questions

Can I deduct my mortgage payment as an expense?

Only the interest portion. Mortgage principal is not deductible because it builds equity in the property. Your lender will send you a Form 1098 each year showing how much interest you paid; that is the amount you deduct. The principal portion is not an expense for tax purposes, even though it reduces your cash flow.

What if I live in part of the building and rent out the rest?

You can only deduct expenses for the rental portion. If you own a duplex and live in one unit and rent the other, you deduct half of the property tax, insurance, and utilities, plus all expenses specific to the rental unit. You cannot deduct expenses for your own living space. Keep separate records for the rental portion to make this clear to the IRS.

Do I count the security deposit as rental income?

No. A security deposit is not income; it is money held in trust for the tenant. You only report it as income if you keep part or all of it — for example, if you deduct damages from the deposit. The amount you actually keep is reported as income in the year you keep it. The amount you return to the tenant is not income at all.

How do I handle a tenant who pays late or does not pay?

The IRS requires you to report income on a cash basis (when you receive it) or an accrual basis (when it is owed), depending on your tax situation. Most small landlords use cash basis, meaning you report rent only when the tenant actually pays. If a tenant owes $1,500 but never pays, you do not report it as income. If you eventually collect it in a later year, you report it then. Keep records of unpaid rent in case the IRS questions why the income is lower than the lease amount.

What if I offer the tenant a discount for paying early or in cash?

You report the amount you actually receive, not the full lease amount. If the lease is $1,500 but you accept $1,400 for early payment, you report $1,400 as income that month. This is legal and common, but document it in writing so you have proof of the agreed amount if questions arise later.