Is Rental Income Active or Passive?

Rental income is generally passive for federal tax purposes, even if you manage the property yourself (IRS Publication 925). The main exceptions are real estate professionals and some short-term rentals.

Being passive doesn't change your income tax rate. It mainly decides what a rental loss can offset. It can also affect the 3.8% net investment income tax, though nonpassive status alone doesn't always remove it.

Two Meanings of "Passive"

• In investor talk, passive means low effort. REITs and silent partnerships are passive; flipping houses or self-managing rentals feels active.
• For the IRS, passive is a tax category. Rentals are passive by default, however many hours you put in.

So a hands-on landlord still has passive rental income for tax purposes. House flipping isn't a rental activity, so these rules don't cover flip profits.

When Rental Income Isn't Passive

Material participation has seven tests of its own; our guide to material participation explains them.

How Rental Income Is Taxed

Your net rental profit is taxed at your ordinary income tax rate, the same as wages. Two other taxes can come up:

• Net investment income tax: if your MAGI is over $200,000 (single) or $250,000 (married filing jointly), a 3.8% tax applies to the smaller of your net investment income, which can include rental income, or the amount your MAGI is over the threshold.
• Self-employment tax: usually doesn't apply to rental income on Schedule E. If you provide substantial services to guests, the rental is generally reported on Schedule C instead, and self-employment tax may apply.

Is rental income earned income?

Usually not. Earned income means wages or self-employment income, and ordinary rental income generally doesn't count as compensation for IRA contribution purposes. Being nonpassive doesn't automatically change that. You can still contribute based on other qualifying compensation, such as wages, or under the spousal IRA rules.

Working out your taxable rental income

1. Add up all rental income, including fees and any part of a security deposit you keep.
2. Subtract operating expenses such as repairs, insurance, management fees, HOA fees and property taxes.
3. Subtract mortgage interest (not principal).
4. Subtract depreciation: for a full year, your depreciable building basis divided by 27.5 years for residential property. The first year is prorated under the mid-month convention.

Example

You buy a rental for $200,000, and $25,000 of the price is allocated to land. Assume $5,000 of eligible closing costs are allocated to the building, giving a depreciable building basis of $180,000. Full-year depreciation is $6,545 ($180,000 / 27.5); the first year would be lower under the mid-month convention.

At a 22% tax rate, the profit adds about $980 to your federal tax bill.

Using Rental Losses

For most landlords, a rental loss is a passive loss. It can:

• Offset passive income, such as profit from another rental.
• Offset up to $25,000 of wages if you actively participate (own at least 10% and make the management decisions). This phases out between $100,000 and $150,000 of MAGI.
• Carry forward if unused. Suspended losses are generally released when you dispose of your entire interest in the activity in a fully taxable sale to an unrelated buyer. If your rentals are grouped as one activity, selling one property may not qualify.

Generally, passive rental losses can't offset dividends or interest unless an exception applies. In the vacancy example, a landlord with $90,000 MAGI who actively participates, files as single or married filing jointly, and isn't blocked by any other limit could deduct the full $1,545 against their salary. Our guide to passive activity loss limitations has the full phase-out table.

How to Report Rental Income

Report rental income and expenses on Schedule E (Form 1040), one column per property. If your rentals show a net loss, you may need Form 8582 to work out how much you can deduct this year.

Depreciation needs careful records: your basis, the date the property went into service and the depreciation already claimed, every year until you sell. Landlord Studio tracks income and expenses by property and builds Schedule E-ready reports.

Final Thoughts

For most landlords, rental income is passive and taxed at ordinary rates. The label matters most in a loss year, when it decides whether the loss offsets your salary now or carries forward.

Accurate records are the starting point. Landlord Studio keeps your rental income and expenses organised by property, so you and your tax preparer have the figures you need when it’s time to file.

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You Might Like

• Passive Activity and Passive Activity Loss Limitations in Real Estate
• Tax On Rental Income: How Much Tax Do You Owe?
• Tax Deductible Expenses Landlords Need to Know About
• How Much Profit Should You Make on a Rental Property?
• Should You Use QuickBooks for Rental Properties?

This guide explains US federal rules as set out in IRS Publication 925. It isn't tax advice for your situation. Talk to a CPA or enrolled agent about how these rules apply to your rentals.