How Is Rental Income Taxed?
Owning and managing a rental property can be a great way to generate passive income through rent payments. But before pocketing that money, it’s important to remember that the Internal Revenue Service (IRS) taxes rental income and requires landlords to report it according to the new 1099 requirement.
To ensure you properly prepare for tax season, we explain how rental income is taxed and the best practices to track this.
What Is Rental Income?
According to the IRS, rental income is “any payment you receive for the use of occupation of a property.” Whether you rent your properties to travel nurses, traditional tenants, or solely rent a room, the IRS considers the money earned through this as rental income.
Other types of payments considered rental income are:
- Advance rent: This is any amount received before the lease term officially begins.
- Security deposits: You do not need to include security deposits if you plan on returning the full amount to the tenant. However, you will need to report this if you keep a part or all of the security deposit. If the security deposit was used to cover unpaid rent, the IRS considers this advance rent and will need to be reported.
- Expenses paid by tenant: If tenants are required to pay expenses you’re responsible for, such as utilities like the water and sewage bill, this is considered rental income.
- Property or services in place of rent: If you receive property or services in replacement of money for rent, you will need to include the fair market value of the property or services in your rental income. An example is when a tenant offers to paint your rental property instead of paying for two months’ rent.
How Rental Income Is Taxed
The IRS requires taxpayers that are landlords to report all of their rental income on their tax return — especially now with the recent 1099 rule requiring landlords to report rental income that exceeds more than $600 via non-employment channels. When filing your taxes, you must also report the payments the same year you receive them, even if they were credited to your tenants for a different year.
A tax professional or accountant can notify you on what tax forms you must file as a landlord, but you can generally use a Schedule E (Form 1040) form to report income and expenses from rental real estate. However, this can vary depending on your rental type, how long tenants have lived in the rental, and if it’s ever been used for personal reasons.
It’s also important to note that the amount your income is taxed will depend on which tax bracket you fall in, a detail a tax professional can share.
Is Rental Income Taxed as Ordinary Income?
Rental income is taxed as ordinary income, but there are deductibles you may qualify for as a property owner that can reduce that amount. These deductions include mortgage payment interest, insurance, utilities, Homeowner Association (HOA) fees, depreciation, repairs, renovations, and more. When filing your taxes, an accountant can help identify what deductions you qualify for.
Pro tip: Track rental property maintenance expenses throughout the year to reduce the amount you owe during tax season.
Can I Avoid Paying Taxes on Rental Income?
No, you cannot avoid paying tax on rental income, as reporting your rental income is an IRS requirement. But you can reduce the amount you owe by working with an accountant to identify what deductions and tax breaks you qualify for. Failing to report your rental income can result in accuracy-related penalties, criminal charges, and tax fraud charges.