What counts as rental income
IRS Publication 527 and IRS Topic 414 define rental income broadly. All of the following are taxable in the year you receive them:
- Advance rent: rent paid before the period it covers is income when received, not when the rental period begins
- Security deposits retained as rent: a deposit applied to a tenant’s final month’s rent is income the year you hold it for that purpose; a deposit you return is not income
- Lease cancellation payments: amounts a tenant pays to break a lease early count as rental income in the year received
- Services rendered in lieu of rent: if a tenant performs services (repairs, painting) instead of paying rent, the fair market value of those services is taxable income
Days you use the property personally do not generate rental income or deductible rental losses. The line between rental and personal use drives the rules below.
Filing rental income: Schedule E
Rental income and expenses go on Schedule E (Form 1040) — not Schedule C. That distinction matters: Schedule C income is subject to self-employment tax (15.3% combined Social Security and Medicare), while Schedule E rental income is not. Most landlords save thousands in self-employment tax by correctly classifying rental activity on Schedule E.
One page of Schedule E covers up to three rental properties. Additional pages handle more properties. Net income or loss from all properties flows to Form 1040.
Common rental expense deductions
Most ordinary and necessary costs to rent and maintain a property are deductible against rental income. Per IRS Publication 527, deductible expenses include:
- Advertising to find tenants
- Auto and travel to your properties for management, rent collection, or maintenance purposes
- Cleaning and routine maintenance
- Insurance premiums on the rental property
- Legal and professional fees (lease drafting, tax preparation for the rental)
- Property management fees
- Mortgage interest paid to banks and lenders
- Property taxes
- Repairs (not capital improvements — see below)
- Supplies used at the property
- Utilities you pay on behalf of tenants
Depreciation is also deductible and is typically the largest single deduction on a landlord’s Schedule E.
Repairs vs. capital improvements: the critical tax distinction
Whether a cost is a repair or a capital improvement determines whether you deduct it this year or over many years.
Repairs restore the property to its original working condition without substantially adding value or extending its useful life. Fixing a broken window, patching a roof leak, repainting walls — these are repairs. Deduct them in full in the year you pay.
Capital improvements add value, extend useful life, or adapt the property to a new use. A new roof, a kitchen remodel, a room addition — these must be capitalized and depreciated, not deducted immediately.
A practical safe harbor: under IRS regulations, amounts of $2,500 or less per item or invoice can generally be expensed immediately rather than capitalized, provided you don’t have an applicable financial statement. Routine maintenance — cleaning, servicing HVAC units, inspecting fire safety systems — also qualifies for immediate deduction.
Depreciation: typically your biggest rental deduction
Residential rental property depreciates over 27.5 years using the straight-line method — an annual deduction of roughly 3.64% of the building’s cost basis (excluding land, which cannot be depreciated). This deduction applies every year you hold the property, whether or not you spend money on it that year.
For a property with a $275,000 cost basis allocated to the structure, annual depreciation is approximately $10,000. That deduction reduces your taxable rental income on Schedule E every year for 27.5 years.
When you sell, accumulated depreciation is recaptured and taxed at a maximum federal rate of 25% — lower than ordinary income rates, but real. Accurate records of cost basis and annual depreciation claimed are essential for a clean exit. The IRS assumes you took the maximum allowable depreciation even if you didn’t actually claim it, so unclaimed depreciation doesn’t escape recapture. For the full mechanics of depreciation schedules, component depreciation, and bonus depreciation options, see our rental property depreciation guide.
Passive activity loss rules and the $25,000 allowance
Rental activities are passive by default. IRS Publication 925 explains that passive losses can only offset passive income — not wages, salary, or active business income — unless a specific exception applies.
The most important exception for individual landlords is the active participation rule under §469(i). You qualify if you:
- Own at least 10% of the rental property, and
- Make bona fide management decisions — approving new tenants, authorizing repairs, setting rental terms — even if you hire a property manager for daily operations
Under this rule, you can deduct up to $25,000 of net rental losses against ordinary income each year.
The $25,000 allowance phases out between $100,000 and $150,000 of adjusted gross income: for every dollar above $100,000, the allowance shrinks by 50 cents, reaching zero at $150,000 AGI. Losses that cannot be used in the current year are “suspended” and carry forward, available to offset passive income in future years or fully deductible when you dispose of the property in a taxable sale.
The real estate professional exception
A separate exception removes the passive-activity cap entirely. If you qualify as a real estate professional for a tax year, your rental activities are non-passive and rental losses are fully deductible against any income.
The two-part threshold: you must spend more than 750 hours per year in real property trades or businesses in which you materially participate, and more than half of your total personal services for the year must be in real property activities.
For a spouse who works in real estate full-time, 750 hours represents roughly 15 hours per week across the year. Time spent managing your own rental properties counts toward the threshold — but only if you own them directly and materially participate in their management (not through a limited partnership where you are passive).
Personal use and vacation home rules
Section 280A applies different rules when you also use a rental property personally. If personal use exceeds the greater of 14 days or 10% of the days rented at fair market value in a year, the IRS classifies the property as a vacation home:
- Expenses must be allocated between personal and rental use proportionally by days
- You cannot deduct a net loss from the rental activity against other income
- Rental income is still taxable
The flip side: if you rent a property for fewer than 15 days in a tax year, you exclude the rental income from gross income entirely. The tradeoff is that rental expenses are also not deductible. You may still claim mortgage interest and property taxes as personal itemized deductions on Schedule A.
Short-term rentals: AirBnB and VRBO
When the average rental period is 7 days or less, the rental activity may be treated as a business rather than a passive rental. Two consequences follow:
- Losses are not constrained by the passive activity rules — you may deduct them against ordinary income without the $25,000 cap
- If you provide substantial services similar to a hotel (regular cleaning, meals, daily maid service), profits become subject to self-employment tax
Most traditional landlords renting by the month are unaffected by this rule. Property owners listing on short-term platforms who provide concierge-level services should determine their classification before filing — the consequences affect both deductions and self-employment tax liability.
Selling a rental property
A rental property sale triggers two separate tax calculations:
- Depreciation recapture — taxed at a maximum federal rate of 25% on accumulated depreciation taken over your ownership period
- Capital gain on appreciation above your adjusted cost basis (original cost plus improvements, minus accumulated depreciation), taxed at long-term capital gains rates of 0%, 15%, or 20% depending on your income
A 1031 exchange can defer both taxes if you reinvest proceeds into a qualifying replacement property within IRS-prescribed timelines. See our 1031 exchange guide for the rules, and our overview of capital gains taxes for how rates are determined.
For insurance coverage questions on rental and vacation properties, our rental and vacation property insurance guide covers the policy types landlords need to protect their investment.
This content is for educational purposes only and does not constitute tax advice. Consult a qualified tax professional for guidance specific to your situation.