You pay tax on rental income minus your mortgage interest and other expenses, not on the full rent you collect

When you rent out a property with a mortgage, the IRS taxes you on your net rental income — the money left after you subtract mortgage interest, property taxes, repairs, insurance, and other costs. You do not pay tax on the full rent amount. This is the single biggest difference between rental income and other kinds of income: the mortgage interest portion of your payment is deductible, which lowers your taxable income significantly in the early years of the loan.

The mortgage principal you pay — the part that builds equity — is not deductible. Only the interest is. This matters because in year one of a 30-year mortgage, most of your payment goes to interest, so your deduction is large. By year 20, most of your payment is principal, so your deduction shrinks. You report this on Schedule E (Form 1040), which is where the IRS expects to see rental income and expenses.

Key Takeaways

  • Mortgage interest is fully deductible from rental income; mortgage principal is not.
  • You deduct the interest portion only, which you can find on your annual mortgage statement or by asking your lender.
  • Other expenses — property tax, insurance, repairs, utilities you pay, depreciation, and HOA fees — also reduce your taxable rental income.
  • If your total deductions exceed your rental income, you may have a rental loss, which can offset other income under certain rules.
  • You report all rental income and expenses on Schedule E, filed with your Form 1040 tax return.

How to find your mortgage interest amount for tax purposes

Your lender sends you a Form 1098 (Mortgage Interest Statement) each January for the previous year. This form shows the total interest you paid during that year, broken down by month if you request it. The interest amount on Form 1098 is the number you use on Schedule E. If you did not receive a Form 1098, contact your lender directly — they are required to send it, and if they fail to, you can still deduct the interest if you have your mortgage statements as proof.

If you paid off the mortgage during the year or refinanced, the Form 1098 will show only the interest paid before the payoff or refinance date. If you made extra principal payments beyond your regular monthly payment, those do not change the interest deduction — you still deduct only the interest actually paid. Some lenders allow you to request an interest breakdown by payment if you need to know exactly how much of each monthly payment was interest versus principal.

What other expenses reduce your rental income tax

Beyond mortgage interest, you can deduct any ordinary and necessary expense of operating the rental property. This includes property taxes (the full amount, not just the portion related to the rental), homeowners insurance, liability insurance, repairs and maintenance, utilities if you pay them, HOA fees, property management fees, advertising for tenants, and legal fees for lease disputes. You can also deduct depreciation, which is a non-cash deduction that spreads the building's cost over 27.5 years.

Expenses you cannot deduct include mortgage principal, capital improvements (major upgrades that add value or extend the life of the property — these are depreciated instead), personal use of the property, and expenses for properties you own but do not rent out. If you use part of your home as a rental (like renting out a room), you can deduct only the expenses that explore to that portion. Keep receipts and records for all expenses; the IRS expects documentation if you are audited.

How depreciation works and why it matters

Depreciation is a deduction for the wear and tear on your building over time. The IRS assumes a residential rental building loses value over 27.5 years, so you divide the building's cost (not the land) by 27.5 and deduct that amount each year. This is a non-cash deduction — you do not actually spend money, but you reduce your taxable income. Depreciation can be substantial in early years and is one reason rental properties often show a loss on paper even when you collect more rent than you pay in actual expenses.

When you sell the property, the IRS recaptures the depreciation you claimed and taxes it at a higher rate (25 percent, rather than your ordinary income tax rate). This means depreciation deductions are not truly "free" — they defer tax to the year you sell. However, if you do not plan to sell for many years, the deferral is valuable. You calculate depreciation on Form 4562 and report it on Schedule E.

When rental expenses exceed your rental income

If your deductions (mortgage interest, property tax, insurance, repairs, depreciation, and other expenses) total more than your rental income, you have a rental loss. You can use this loss to offset other income — such as wages from a job or investment income — but only if you meet the IRS rules for passive activity losses. Most landlords may have access to as passive investors, which means losses are limited to $25,000 per year if your modified adjusted gross income is under $100,000. Above that income level, losses phase out and may not be deductible at all in that year.

If you cannot deduct a loss in the current year because of the passive activity limits, the unused loss carries forward to future years. When you sell the property, any unused losses can offset the gain from the sale. This is another reason to keep detailed records — you may need to prove the loss amount years later.

The difference between cash flow and taxable income

Your actual cash flow (the money in your bank account after paying the mortgage and expenses) is different from your taxable rental income. If you collect $2,000 in rent and pay $1,200 in mortgage, $300 in property tax and insurance, and $200 in repairs, your cash flow is $300. But if your mortgage interest was $900 and principal was $300, your taxable income is $2,000 minus $900 (interest) minus $300 (tax and insurance) minus $200 (repairs) minus depreciation. Depreciation might be $150, leaving you with a taxable loss of -$50, even though you had $300 in cash.

This is why some landlords show losses on their tax returns while still building equity and having positive cash flow. The loss is real for tax purposes — it reduces what you owe the IRS — but it does not mean the property is losing money in practical terms. Understanding this difference helps you plan for both your tax bill and your actual cash needs.

How to report rental income and expenses on your tax return

You report all rental income and expenses on Schedule E (Form 1040), which is part of your individual tax return. Schedule E has separate lines for rental income, mortgage interest, property tax, utilities, repairs, depreciation, and other expenses. You total your expenses, subtract them from your rental income, and report the net income or loss. If you own multiple properties, you fill out a separate Schedule E for each one and combine the results.

If you have a rental loss and may have access to to deduct it under the passive activity rules, you report it on Schedule E and carry it to Form 1040, where it reduces your overall taxable income. If you do not may have access to to deduct the loss in that year, you still report it on Schedule E, but you do not use it to reduce other income — instead, it carries forward. Many tax software programs walk you through Schedule E line by line, but a tax professional can help may support you are claiming all deductions and following the passive activity rules correctly.

Frequently Asked Questions

Can I deduct mortgage principal as a rental expense?

No. Only the interest portion of your mortgage payment is deductible. Principal is not an expense — it is a return of your own money and builds equity in the property. Your Form 1098 shows only the interest, which is what you deduct on Schedule E.

What if I pay property tax and mortgage interest on a rental property I own with someone else?

You deduct only your share of the interest and property tax. If you own the property 50/50 with a partner and the mortgage interest is $5,000, you deduct $2,500. Your lender or tax professional can help you determine your exact share if the ownership is not equal.

Do I have to deduct mortgage interest, or can I choose not to?

You must deduct mortgage interest on a rental property. The IRS does not allow you to skip a deduction to create a larger loss or to avoid depreciation recapture later. If you want to report a higher taxable income, you would need a different strategy, and a tax professional can discuss your options.

What happens to my rental loss if I sell the property?

Any unused rental losses that you could not deduct in prior years because of passive activity limits can offset the gain from the sale. If you sold for a $50,000 profit but had $30,000 in unused losses, your taxable gain would be $20,000. Unused losses that do not offset the sale gain are lost and cannot be carried forward further.

Do I report rental income differently if the property is in another state?

No. You report all rental income and expenses on Schedule E, regardless of where the property is located. However, you may owe state income tax in the state where the property is located, and some states have different rules for deducting expenses or depreciation. A tax professional familiar with that state's rules can help you file correctly.