Everything You Need to Know About Rental Income Tax

We explore what landlords need to know about reporting their rental income tax and tax deductible expenses for their properties.

Purchasing a rental property can be a great investment. Nonetheless, many people feel hesitant to do so because of worries about how it will impact their income tax. Although rental properties do add an extra layer of complexity to filing your taxes, the actual cost is minimal as there are several ways investors can reduce their tax bills.

To ensure you stay compliant and don’t overpay your taxes, there are a few things you should know about rental income tax.

Reporting Rental Income

You must pay rental income tax on any property for which you receive payment in return for use or occupation. Rental income is taxed as ordinary income and you pay according to your marginal tax bracket, which is between 10% and 37%.

Obviously, any rent the tenant pays is counted as taxable income. However, as well as this you also have to report other forms of income as rental income including the following:

  • Advance rent payments. For example, if a tenant pays for the last month of the lease as well as the first month.
  • Any of the security deposit you end up keeping (such as to cover repairs) counts as taxable income rent payments. However, any you return to the tenant is not. You should make sure to carefully track how much deposit was collected, where it was kept, how much you kept, and how much was returned on your property balance sheet.
  • Expenses your tenant covered that a landlord would typically pay. This includes repairs as well as any agreements for payments you have, such as if the tenant pays utilities and subtracts the amount from the rent.
  • Property services in lieu of rent. You may ask a tenant to maintain the property (for instance, through landscaping or painting) in exchange for a discount on rent. You’ll need to pay for rental income tax on the amount you deduct from the service — and the amount should be the fair market value.
  • Fees for early lease termination.
  • Payments you receive through a lease-with-option-to-buy agreement.

Essentially, if you collect a payment, in either money or services from a tenant you need to report it as taxable income. However, it’s also worth noting that many of these are also deductible expenses. For example, if you keep $300 of your tenant’s deposit to cover repairs you would also report $300 of deductible expense for those repairs.

If you are a cash basis taxpayer (most people are), you’ll need to pay rental income tax for the year that you receive the payments, no matter when the amount is actually owed to you. This includes all the income you receive constructively, meaning it’s the full amount available to you by the end of the year, even if you haven’t yet taken possession of the funds — such as a check that you haven’t yet cashed.

If you use the accrual method of accounting, you should report income as you earn it — and expenses for tax deductions as you incur them.

Tax Deductions For A Rental Property

One of the advantages of owning rental property is the ability to mitigate your tax liability with deductible expenses. The amount you owe in taxes may be significantly lower than it first appears because of deductions. You can deduct all the expenses associated with preparing the property for your tenants and maintaining the property, including expenses you’ve already specified as rental income. Deductible expenses fall into three main categories:

  • Ordinary expenses. Costs related to managing and maintaining the property, such as materials, supplies, repairs, cleaning, utilities, pest control, yard maintenance, and trash removal.
  • Necessary expenses. Anything considered appropriate for an owner of a rental property to pay. This includes mortgage interest, property tax, advertising, utilities, insurance, fees to a property manager, HOA or condo fees, leasing commissions, licenses and permits, legal fees, and travel expenses.
  • Depreciation. This covers the purchase price of the property and costs related to improvements, such as restoring the property or adapt it for a new purpose. Depreciation allows you to claim back the full value of an asset including the property itself over a period deemed its useful life. For residential rentals, this is 27.5 years, and for commercial property 39 years. This can have a major impact on your end-of-year rental income tax.

See our full list of deductible expenses for rental properties here.

Deductions are more complicated if your rental property is also for personal use — even if you don’t use your property as a residence. In this case, you’ll need to split the expenses, deducting your rental expenses separately from your personal expenses.

You can avoid missing out on the full deductions you could be entitled to by limiting the amount of time you use the property yourself. You will only need to divide expenses if you personally use the property for more than 14 days or more than 10 percent of the days you rent the property (whichever is greater). If you want to use this tactic, it’s important to calculate how many days you’ll likely be able to rent the property — such as if it’s a vacation home and only in demand during certain times of the year.

Rental Income Tax Forms

You may need to file several rental tax income forms, even if your property is not for personal use.

The main form that owners of rental properties will need to file is a Schedule E form, which you file with your 1040. You report all your income and rental expenses on this form. If you have any personal expenses associated with your rental property, you may be able to deduct some of them using a Schedule A form.

For depreciation and improvements to your property use Form 4562. This allows you to report depreciation from the year you began leasing your rental property. Note that you’ll only be able to deduct a percentage of expenses in the year you incur them.

Finally, if net investment income tax applies to your rental income, you need to file Form 8960. Working through the form will show you if this form applies to your situation.

You may also be required to file a 1099 if you have paid any contractors over $600 during the tax year.

Find out more about the Schedule E form →

Managing Your Rental Income Tax

Owning a rental property is a great way to increase your income, but it’s not quite a passive income. Calculating how much you owe in taxes and filing all the necessary rental income tax forms can be a headache, especially if you have a large number of deductions and you want to ensure you pay the minimum amount of tax. Sorting out your income taxes is one of the most stressful aspects of renting a property.

Landlord studio dashboard

The solution is to use software that does all the hard work for you. Landlord Studio makes it easy to keep a record of your income and expenses by automating processes and reducing manual data entry with features such as bank feeds, smart scan receipts, and online rent collection.

The software also creates professional reports that you can customize and share with your accountant, stakeholders, or anyone else who needs the information. Best of all, you’ll have everything ready for your rental income taxes at the end of the year.

* First 3 properties free.