Buying an investment property to rent is useful in a variety of ways. It can help you diversify your investment portfolio by adding real estate, which provides a regular income and can serve as a hedge against inflation. Rental income can add up quickly, especially if you’re in the position to buy and hold multiple properties in a thriving rental market.
At CMP, many of our clients own real estate; one of their biggest concerns is taxation. They want to know how much they will owe in federal income taxes and what they can do to simplify their taxes and avoid overpaying. We have created this guide to help you understand how taxation on rental income works.
Do You Pay Taxes on Rental Income?
The IRS generally requires that rental income be reported and taxed as ordinary income. One exception: if you rent out a home for fewer than 15 days during the year and it counts as your residence (your personal use is more than 14 days, or more than 10% of the days it’s rented, if that’s greater), you don’t report that rent, and you can’t deduct rental expenses for it.
At the federal level, taxes are broken down into brackets. Tax rates build from the bottom up, so if you move into a higher tax bracket due to rental income, you’ll pay a higher tax rate on the amount of income that falls into that bracket.
The good news is that there are many ways to offset some of your tax liability as it relates to rental income, including the option to deduct expenses related to your rental properties.
Understanding the Concept of Rental Income
All rental income must be reported as part of your gross income, but it’s important to understand what the IRS considers to be rental income. You’ll need to include the following:
- All amounts you receive for the use or occupation of property you own.
- Advance rent (rent you receive before the period covered by the payment.)
- Security deposits (If you do not keep a security deposit, you are not required to report it, but you must report any amount you retain in the year you retain it.)
- Payments for canceling a lease.
- Expenses paid by a tenant. (For example, if a tenant pays water and sewage expenses that are not part of your leasing agreement.)
For example, if you received payment for the first and last month’s rent, you would need to report all that you received, with the first month being rent and the second being advance rent.
How is Rental Income Taxed?
Rental income is taxed at the same rate and in the same way as ordinary income. You must report it to the IRS as income and pay taxes accordingly. If you earn enough rental income to push you into a higher tax bracket, your tax percentage for some of your rental income will increase.
One big advantage of rental income is that it’s usually not subject to self-employment tax. Self-employed people pay 15.3% self-employment tax on most of their net business earnings, though the Social Security part stops at an annual cap. Most ordinary rental income is exempt. The exceptions include rentals where you provide substantial services to tenants (such as a short-term rental run like a hotel), rentals that are part of a real estate dealer’s business, and certain farm rental arrangements where the owner materially participates.
What is the Tax Rate on Rental Income?
Your rental profit is added to your other income, and your total taxable income is taxed at the 2026 tax brackets for single filers:
- 10% on taxable income up to $12,400
- 12% from $12,401 to $50,400
- 22% from $50,401 to $105,700
- 24% from $105,701 to $201,775
- 32% from $201,776 to $256,225
- 35% from $256,226 to $640,600
- 37% over $640,600
Keep in mind that the United States uses a progressive tax system, so even if you are in the highest income tax bracket you won’t pay the highest rate on all of your income. For example, you’d pay 37% only on taxable income over $640,600.
You will also need to keep in mind the tax laws, rates, and regulations in the state where you live. While a few states have no income tax, most do. If you live in a state that has an income tax, you will also be required to report your rental income and pay taxes on the state level.
How to Report Rental Income on Taxes
Most individual landlords report rental income and expenses on Schedule E (Form 1040), Part I, whether they rent a room, an apartment or an entire building. If you provide substantial services to tenants, the income may belong on Schedule C instead, and rentals owned by a partnership, multi-member LLC or corporation are reported on that entity’s return. On the form, there is space to list your total income for the property you own, your expenses related to the property, and the depreciation of the property. You can see the Instructions for Form 4562 to calculate depreciation to enter on Schedule E, Line 18.
Schedule E has room for three properties. If you have more, attach as many Schedules E as you need, list three properties on each, and fill in the totals lines on only one of them.
You should refer to your state taxing authority for instructions on how to report rental income when you file your state income tax return.
Ways to Reduce Taxes on Rental Income
There are many ways to reduce the taxes you pay on rental income. We recommend working with a tax professional to be sure you take advantage of every available deduction and don’t pay more than you need to.
Here are some of the most common tax deductions on rental properties to be aware of before you report your rental income and pay taxes on it.
Depreciation
Anybody who owns rental property, whether it is a residential property or commercial property, has the option to take a tax deduction for depreciation. Depreciation is spread out over the lifetime of the property. Per IRS rules, the lifetime is 27.5 years for any residential property and 39 years for commercial property.
For example, say you buy a commercial property for $1,000,000, and $200,000 of that is the land. Land can’t be depreciated, so you’d depreciate the $800,000 building over 39 years, roughly $20,513 a year (a little less in the first and last years). When you sell, the part of your gain that comes from depreciation on the building is generally taxed at up to 25%, not your full ordinary rate. This is often called depreciation recapture.
Mortgage Interest
When you buy a personal residence, mortgage interest is generally deductible only on up to $750,000 of debt ($375,000 if married filing separately), or $1 million for qualifying debt taken out before December 16, 2017. Rental property interest isn’t subject to that cap. You deduct it as a rental expense, though other limits can still apply, such as the passive activity rules and, for larger businesses, the business interest limit.
To claim this deduction, you’ll usually use the Form 1098 your lender sends showing the interest you paid. If you have seller financing or a private loan, you can still deduct the interest using your own records.
Property Tax/Property Insurance
Another difference between rental properties and your primary residence is how you claim deductions for the property taxes you pay. Like mortgage insurance, property taxes must be reported as a business expense and deducted accordingly.
The same is true of any insurance you purchase for your rental properties. You should keep track of the insurance premiums you pay and deduct them as a business expense when you report income for your rental properties.
Property Expenses
There are a host of other deductible expenses that property owners can use to reduce their taxes when they report income from rental properties and file their federal taxes.
- Repairs and maintenance that keep the property in good working condition, such as fixing a leak, patching a roof or repainting, are generally deductible in the year you pay them.
- Property management expenses, such as fees you pay a property manager or management company, are deductible. Your own time spent managing the property isn’t.
- Advertising expenses may be deductible if you pay to advertise vacant apartments and attract new tenants.
Improvements that add value, extend the property’s life or adapt it to a new use, such as replacing a roof or repaving a parking lot, have to be capitalized instead of deducted as repairs. You generally depreciate them over time, though some improvements, such as appliances or certain improvements to commercial buildings, may qualify for Section 179 or bonus depreciation.
Pass-Through Deduction
It’s common for real estate investors to form a Limited Liability Company (LLC) to buy and manage rental property. An LLC doesn’t change whether you qualify for the pass-through deduction (QBI), though.
The Qualified Business Income (QBI) deduction, up to 20% of qualified business income, is available if your rental activity rises to the level of a trade or business. The IRS also offers a safe harbor. You can qualify if you keep separate books for the rental, perform at least 250 hours of rental services each year (or in any three of the last five years for rentals held four years or more), keep contemporaneous records of those services and attach the required statement to a timely filed return. Some rentals can’t use the safe harbor, including property you also use as a residence and triple-net leases. Missing the safe harbor doesn’t by itself rule out the deduction.
Do You Pay Self-Employment Taxes on Rental Income?
As noted above, most rental income isn’t subject to self-employment tax.
The IRS treats rental income as taxable, but usually not as self-employment income.
Potential Penalties for Not Properly Reporting Rental Income
It’s essential to report your rental income to the IRS and any state taxing agency to avoid penalties. There are two penalties to be aware of on the federal level.
- A 20% penalty on the portion of tax underpaid because of the error.
- A 75% civil fraud penalty on the portion of tax underpaid because of fraud, such as deliberately hiding rental income.
You may also be liable for late fees. For that reason, you’ll need to be diligent about reporting all rental income and paying any appropriate taxes on time.
Tax Reforms Related to Rental Income
The tax code changes frequently. Here are a few tax reforms to be aware of that may affect the tax you pay on rental income:
- The QBI deduction is now permanent. Starting in 2026, there’s also a $400 minimum deduction if you have at least $1,000 of qualified business income from active businesses you materially participate in. Both amounts will be adjusted for inflation after 2026.
- You must report all of your taxable rental income, no matter how small, whether or not you get a form. (The short-rental exception above still applies.) If tenants pay through a payment app or online marketplace, you’ll generally get a Form 1099-K once you receive more than $20,000 and more than 200 payments in a year (you need both). Rent paid by credit or debit card can be reported on a 1099-K at any amount.
- Security deposits are not taxable when you collect them, but they are taxable if a tenant moves out and you keep part or all of the deposit to pay for property damage.
- If you collect the first and last month’s rent from new tenants, you must report everything you collect as rental income.
Working with a professional accountant will ensure that you stay on top of tax reforms and changes that may have an impact on how you pay taxes on your rental income.
Get Help Navigating the Complexities of Rental Income Tax
Understanding the tax implications of rental income can be overwhelming, particularly if you have just started earning rental income. The information in our guide can help you report your rental income, take all allowable deductions, and avoid overpayments and penalties.
Are you in search of help to manage your taxes for rental income? Look no further! CMP is equipped and ready to guide you through this complex process. We provide comprehensive income tax services that cater to various needs, including rental income tax assistance.
