Rental properties are an incredible source of monthly cash flow.
What can eat away at that cashflow?
Expenses.
Many beginner real estate or even experienced investors may not factor in taxes as a part of those expenses.
So, how is rental income taxed?
Here’s what you need to know about rental income taxes so you can start planning for this years taxes — and so that you can reduce your tax burden in the future.
How is Rental Income Taxed in 2024?
Rental income is taxed in the same way as other forms of income.
This means you’ll pay the same tax rates as you would on income from a job.
You won’t need to pay self-employment tax, as the IRS considers rental income to be passive income, rather than income from a business.
Your tax rate will be based on your total taxable income for the year.
There are seven income tax brackets, and the more money you make, the higher your tax bracket will be.
As with many other forms of income, you’ll be able to lower your taxable rental income by taking qualified deductions.
What Counts as Rental Income?
As a landlord, there are many ways that you could receive money from your tenants.
Regular Monthly Payments
Of course, regular monthly rent payments will count as income.
Rent in Advance
If your tenant pays rent in advance, this will also count as income when you receive it. For example, if the tenant pays first and last month’s rent to move in, that income is taxable at the time you receive it.
Security Deposits
However, security deposits do not count as rental income, as you intend to pay them back when the lease ends.
On the other hand, if you take money from the security deposit to cover any damage, that will count as rental income.
Fees
Finally, any fees that you collect from tenants will count as rental income.
These could include
- application fees
- lease cancellation fees
- late payment fees
- and more
Common Rental Property Tax Deductions
There are many tax deductions available for rental property owners.
These deductions will lower your total taxable income, therefore reducing the total amount you’ll pay.
Some of the top tax deductions available for rental property owners include:
- Maintenance: As a landlord, you’ll be responsible for maintenance on your property. For example, your HVAC system and roof will need regular cleaning. If you have a yard, that will require frequent upkeep as well. The cost of maintenance is tax-deductible.
- Repairs: If something breaks on your property, you will also be responsible for repairing it. You can deduct the cost of services and materials used for repairs on your taxes.
- Utilities: Any utilities that you pay for your tenants will be tax-deductible. For example, many landlords pay for heat, water, and garbage service. However, utilities that your tenants pay are not tax-deductible.
- Property management fees: Many landlords outsource their property management to a third-party service provider. These fees are tax-deductible.
- Property taxes: You’ll need to pay property taxes to your local government, but luckily, these are tax-deductible as well.
- HOA fees: If you are part of a homeowner’s association for your rental property, you can deduct any fees paid to that organization on your taxes.
- Advertising: When your rental unit is vacant, you’ll need to advertise to find new tenants. Any advertising fees directly related to your property are tax-deductible.
- Insurance: You can deduct the cost of homeowner’s insurance or any other insurance related to your rental property on your taxes.
- Travel expenses: If you need to travel to and from your property at any point to manage it, you can deduct associated travel costs on your taxes. For example, you can deduct the cost of gas or the transit fares for those trips.
- Professional fees: If you work with lawyers, accountants, or other professionals to manage your properties, their fees are tax-deductible.
How to Report Your Rental Property Income on Your Taxes
It’s very important for landlords to keep track of their rental property income throughout the year.
Save receipts of each rent payment and any other relevant documents.
You will report your income using the Schedule E 1040 form for Supplemental Income and Loss.
Make sure to file both your federal and state taxes.
How to Calculate Depreciation
One tax deduction that is very helpful for rental property owners is depreciation.
The IRS allows you to take depreciation deductions for residential properties over a period of 27.5 years.
To calculate your depreciation deduction, you’ll need to start by calculating your cost basis.
The formula for cost basis is as follows:
(Home value + Closing costs) – Land value = Cost Basis
Your cost basis is the value of your rental property and your closing costs, minus the value of the land that it’s on.
Once you’ve calculated your cost basis, divide that amount by 27.5.
This is the amount that you’ll be able to deduct on your taxes each year during the depreciation period.
The Bottom Line: How is Rental Income Taxed?
Whether you’re renting out one property or 10, don’t forget that taxes are an expense that can eat into your monthly cashflow.
Use this guide to reduce your tax burden now and in the future, so that you can keep more money in your pocket.
Do you have a house-flipping business? If so, learn how taxes on flipping houses works with our step by step guide.
