Yes, you owe federal income tax on rental income, and most states tax it too

Any money you receive from renting out property — whether it's a house, apartment, garage, or parking space — counts as taxable income to the IRS. You report it on your federal tax return every year, and you pay tax on the full amount you collect, minus the expenses you're allowed to deduct. The IRS does not treat rental income differently from wages or self-employment income; it all goes on the same return and is taxed at your ordinary income tax rate.

Most states also tax rental income at their state income tax rate. A few states (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming) have no state income tax at all, so residents of those states owe federal tax only. If you live in a state with income tax, you'll file a state return as well as your federal one.

The amount you actually owe depends on two things: how much rent you collected, and how much you spent on expenses related to the property. The IRS lets you subtract mortgage interest, property taxes, insurance, repairs, utilities, advertising for tenants, and other ordinary costs of running the rental. You report the income and deductions on Schedule E (Supplemental Income and Loss), which attaches to your Form 1040.

Key Takeaways

  • Rental income is taxable at both the federal level and in most states, and you report it on Schedule E of your federal tax return.
  • You pay tax on the rent you collect minus deductible expenses like mortgage interest, property taxes, insurance, repairs, and utilities.
  • If you have a mortgage, the interest portion is deductible, but the principal you pay down is not.
  • Depreciation of the building itself reduces your taxable income each year, but you may owe tax on that depreciation when you sell the property.
  • If your rental expenses exceed your income in a year, you may be able to deduct the loss, subject to passive activity loss limits that depend on your income level.

What counts as rental income and what you can deduct

Rental income includes the monthly rent your tenants pay, but also security deposits that you keep (not ones you return), late fees, pet fees, and any other payments tied to the use of the property. If you furnished the rental or provided utilities, those amounts are still rental income. If a tenant pays you to break a lease early, that's income too.

Deductible expenses are costs you pay to earn that rental income. The main ones are mortgage interest (not principal), property taxes, homeowners or landlord insurance, repairs and maintenance, utilities you pay, advertising to find tenants, property management fees, and HOA fees if applicable. You can also deduct the cost of tools and equipment under $2,500 (or depreciate larger items). Mileage to and from the property, office supplies, and tax preparation fees related to the rental are deductible. Improvements that add value to the property — a new roof, new kitchen, new flooring — are depreciated over many years rather than deducted all at once.

You cannot deduct the principal portion of your mortgage payment, even though it reduces your equity. You also cannot deduct personal use of the property. If you rent out a house for nine months and live in it yourself for three months, you can only deduct expenses for the nine months you rented it, and you must allocate shared costs like property taxes and insurance proportionally.

How depreciation works and why it matters at tax time

Depreciation is a deduction that reduces your taxable rental income each year, even though you don't actually spend the money. The IRS assumes that buildings wear out over time, so it lets you deduct a portion of the building's cost (not the land) over 27.5 years for residential rentals. If you bought a house for $400,000 and the land was worth $100,000, you depreciate the $300,000 building portion at roughly $10,909 per year.

Depreciation is valuable because it lowers your taxable income without a cash outflow. But there's a catch: when you sell the property, the IRS taxes you on all the depreciation you claimed, even if the property actually went down in value. This is called depreciation recapture, and it's taxed at 25 percent (higher than your ordinary income tax rate in most cases). If you claimed $100,000 in depreciation over ten years and then sold, you'd owe 25 percent tax on that $100,000 regardless of whether you made or lost money on the sale.

You still benefit from depreciation in most cases because you defer the tax for years while you own the property, and you may be in a lower tax bracket when you sell. But it's important to understand that depreciation is not a permanent tax break — it's a deferral.

Passive activity loss limits and when you can deduct rental losses

If your rental expenses exceed your rental income in a year, you have a loss. Whether you can deduct that loss depends on your income level and how involved you are in managing the property.

If your modified adjusted gross income (MAGI) is $150,000 or less and you actively participate in managing the rental (meaning you make decisions about tenants, repairs, and rent amounts, even if a property manager handles day-to-day work), you can deduct up to $25,000 of rental losses against your other income. This is called the passive activity loss exception. If your MAGI is between $150,000 and $200,000, the $25,000 limit phases out by $1 for every $2 of income above $150,000. If your MAGI is $200,000 or more, you cannot use this exception at all.

If you don't meet the active participation test, or if your loss exceeds the $25,000 limit, the excess loss is suspended. You can't deduct it in that year, but you carry it forward to future years. If you eventually sell the property, you can deduct all suspended losses in the year of sale.

Real estate professionals — people whose primary business is real estate and who work more than 750 hours per year in real estate — are not subject to passive activity loss limits and can deduct all rental losses. This is a narrow category and requires careful documentation.

Self-employment tax and when you owe it on rental income

Rental income from a property you own is generally not subject to self-employment tax (Social Security and Medicare tax). You pay income tax on it, but not the additional 15.3 percent self-employment tax that applies to business income or wages.

The exception is if you provide substantial services to tenants beyond normal landlord duties. If you operate a hotel, bed and breakfast, or furnished short-term rental where you provide daily housekeeping, meals, or other services, the IRS may classify it as a business rather than a rental, and you'd owe self-employment tax. The line between a rental and a service business is fact-specific, and the IRS looks at how much time you spend, what services you provide, and whether guests expect those services.

If you're unsure whether your situation crosses into self-employment tax territory, a tax professional who knows your specific setup can advise you. Most traditional long-term rentals do not trigger self-employment tax.

Reporting rental income on your tax return

You report rental income and expenses on Schedule E (Form 1040), which is titled "Supplemental Income and Loss." You list each property separately if you own more than one. Schedule E asks for the address of the property, the number of days it was rented and the number of days you used it personally, and then all your income and expenses for the year.

You must file Schedule E even if you have a loss, because the IRS needs to see the calculation. If you have a loss that exceeds the passive activity loss limits, you'll also need to file Form 8582 (Passive Activity Loss Limitations) to show how much of the loss you can deduct and how much is suspended.

Keep records of all rental income and expenses for at least three years (the IRS can go back further if it suspects underreporting). This means bank statements showing deposits, receipts for repairs and maintenance, property tax bills, insurance statements, mortgage statements showing interest paid, and any other documentation of money in and money out. If you use accounting software or a spreadsheet to track these, keep that too.

State income tax on rental income

If you live in a state with income tax, you report rental income on your state return as well. Most states follow federal rules closely — they tax rental income and allow the same deductions — but some have differences. A few states tax capital gains (profit when you sell) at a different rate than ordinary income, which can affect how you plan a rental sale.

If you own rental property in a state where you don't live, you may owe tax to both your home state and the state where the property is located. Some states offer credits to avoid double taxation, but the rules vary widely. This is a situation where a tax professional familiar with multi-state rentals is worth the cost.

Frequently Asked Questions

Do I have to report rental income if I only rented the property for part of the year?

Yes. You report the income for the months you rented it and deduct the expenses for those months. If you rented for six months and lived in it for six months, you allocate shared expenses like property taxes and insurance between the two periods and only deduct the rental portion.

Can I deduct the cost of buying the property or improvements I made?

You cannot deduct the purchase price — that's a capital asset. But you depreciate the building portion over 27.5 years. Improvements like a new roof or kitchen are also depreciated, not deducted when ready. Repairs and maintenance (fixing a leaky faucet, repainting) are deducted in the year you pay for them.

What if I have a loss on my rental property — can I deduct it from my other income?

It depends on your income level and whether you actively manage the property. If your modified adjusted gross income is $150,000 or less and you actively participate, you can deduct up to $25,000 of losses. Above $150,000, the limit phases out. Losses above the limit are suspended and carried forward to future years or until you sell.

Do I owe self-employment tax on rental income?

No, not on ordinary rental income from a property you own. Self-employment tax applies to business income and wages. If you provide substantial services (like running a bed and breakfast with daily housekeeping), the IRS may classify it as a business and self-employment tax could explore.

What happens to depreciation when I sell the rental property?

You owe tax on all the depreciation you claimed, at a rate of 25 percent, even if you sold the property for less than you paid. This is depreciation recapture. You still benefit from depreciation because you deferred the tax for years, but understand that it's not a permanent break.