Navigating taxes on rental income

Owning real estate can be an extra income stream, but it also comes with tax responsibilities. In fact, if you own rental property, you’ll find that you have several additional tax tasks. Specifically, the IRS requires that you report all rental income on your tax return, as well as the associated expenses.

Whether you’re renting one property or many, we’ve detailed what you should know about reporting rental income on your tax return, including the rental income tax rate, important rental income tax forms, and general tips for claiming rental income on taxes.

What qualifies as rental income?

First, let’s define what counts as rental income. Essentially, it’s any payment you receive for the use or occupation of property that you own. You’re responsible for reporting rental property income on your tax return for all your properties. 

Rental income includes:

• Advance rental payments
• Current payments
• Late payments
• Expenses paid by tenants

Payments you receive for lease cancellation and forfeited security deposits are rental income. They’re income for the year:

• The lease is canceled
• The security deposit is forfeited

What’s the rental income tax rate?

Curious what the rental income tax rate is? Well, there’s no one set rate for taxing rental income. Rental income is taxed as ordinary income – using progressive tax brackets, which range from 10 to 37%, depending on your filing status and taxable income. Taxing rental income also requires special tax forms, which we’ll outline next.

Important rental income tax forms to know about

If you rent real estate, you’ll want to be familiar with a few rental income related tax forms. Some of these will show the rental income you received or payment for services. Others will be used to report all of your income (including your rental income). We’ll cover that in the next section.  

1099 for rental income

There are three types of 1099 rental income related forms. We’ll outline them by situation:   

Reporting rental income on your tax return

Typically, the rental income tax forms you’ll use to report your rental income include: Form 1040 or 1040-SR, Schedule E.

Here are the steps you’ll take for claiming rental income on taxes:

1. List your total income, expenses, and depreciation for each rental property on Schedule E.
2. Read the Instructions for Form 4562 to figure your depreciation amount. Enter this number on line 18 of Schedule E.
3. If you have three or more rental properties, attach a Schedule E for each of your properties. On line 1a for each property, include the street address for each property.
   • Fill in the “Totals” column, lines on only one Schedule E. This should be the aggregate total for all rental properties.

Rental property loss and at-risk rules for rental property

Passive loss

Rental income is considered passive income for the passive-loss rules limitation. One of the exceptions is for qualified real estate professionals. If your rental income is more than your expenses, you’ll report the income. However, if your rental income is less than your expenses, you must consult special rules. These rules tell you if you can take the loss against other income.

Limited loss

If rental expenses exceed rental income, or your rental property is partially used for personal use, your loss could be limited. The amount of loss you can deduct may be limited by the passive activity loss rules and the at-risk rules. Tax Form 8582, Passive Activity Loss Limitations, Form 6198, At-Risk Limitations, and Publication 527, Residential Rental Property offer more information on limited loss.

Passive-loss rules

Rental real estate often creates a loss since it has large depreciation deductions and cash expenses, like:

• Mortgage interest
• Insurance
• Taxes

You can calculate your losses this way:

Passive activity deduction – passive activity gross income = passive activity loss

The passive-loss rules determine if you can take the loss against other income. If you can’t, you have to carry over the loss into another year, offsetting that year’s passive income.

Usually, you can’t deduct passive losses from non-passive income, like wages. You might have several sources of passive income, like multiple rental houses. If so, you can deduct the loss from them if the income covers it. If it does not, any excess loss is carried over to later years.

Special loss allowance

You can claim a special loss allowance for rental real estate activities that fall outside the general rule. This means you can take up to $25,000 in losses against non-passive income. You must be an active participant in the activity to qualify.

There’s an exception to this rule. If you’re married filing separately, the amount is either:

• $12,500 if you didn’t live together
• $0 if you lived together in the year

Active participants are those involved in managing the property. This means you do things like:

• Approve new tenants
• Handle leases
• Make decisions about property maintenance
• Your involvement must be significant and bona fide.

If your income goes up, the ability to take the special loss allowance can phase out. This happens if your modified adjusted gross income (AGI) is more than:

• $100,000
• $50,000 if you’re married filing separately and lived apart from your spouse all year

At-risk rules

At-risk refers to what you’ve invested in a particular activity. For rental activities, you’re usually at risk for the:

• Adjusted basis of real properties
• Certain amounts you’ve borrowed
• Cash you’ve invested in the activity

Under the at-risk rules, your losses are limited to amounts you have at risk.

Common questions associated with reporting rental income

1 – “Can you deduct rental expenses on your taxes?”

Yes, you can deduct your expenses in the year you pay them. You can deduct these — and other less common — expenses for your rental property:

• Advertising
• Auto and travel
• Cleaning and maintenance
• Commissions
• Insurance
• Legal and other professional fees
• Mortgage interest paid to banks and other financial institutions — They must be secured by the rental property.
• Repairs
• Real property taxes
• Utilities
• Depreciation expense
• Other expenses specific to your rental — Ex: condo fees or landscaping expenses

2 – “What should I do if I rent a former main home?”

If you convert your main home to rental property, you don’t need to apply the vacation home rules, which we discuss below. This is true if you intend to keep the property exclusively for rental use. Once converted, don’t count days of personal use before the conversion date if either of these applies:

• You rented or tried to rent the property for at least 12 consecutive months.
• You rented or tried to rent the property for a period of fewer than 12 consecutive months. This applies if the period ended because you sold or exchanged the home.

However, this special rule doesn’t apply when you’re dividing expenses between rental and personal use.

Depreciation of converted rental property follows special rules. When you convert property from personal to business use, the basis for depreciation is the smaller of these:

• Adjusted basis on the date of conversion — most common
• Fair market value (FMV) on date of conversion — usually applies when property values are dropping

To figure how much depreciation you can claim, calculate the basis of the property. The basis is usually how much you paid for the property. However, a part of that price applies to the land. You can only depreciate the rental home itself, not the land.

To figure how much the land is worth, get an appraisal of the property. The appraisal should separately state the FMV of the land and the building. You can estimate the value of the land based on the tax assessment statement for the year of conversion. Also, a local real estate firm might give you guidance on land values at the time you bought the land and on the conversion date.

3 – “What are the tax rules associated with vacation home rentals?”

There are a few key rules related to vacation home rentals.

1. You might own a home that you live in part of the year and rent out part of the year. If so, you’ll prorate the expenses you incur between personal and rental use. To figure the ratio of personal and rental use:

• Figure the total days of use by adding together personal days and rental days for the year.
• Divide the number of days the home was rented by the total days of use.
• Since vacation homes usually get this kind of treatment, the rules are known as the vacation home rules.

2. Another related rule is the nontaxable rental – when you rent out a personal home for less than 15 days a year. Your rental income is not taxable and your rental expenses are not deductible. Mortgage interest and real estate taxes are still deductible, but you will use Schedule A instead of Schedule E.
3. You might also be eligible for certain deductions, such as the mortgage interest deduction. Additionally, if you travel to check on the house, or you go there to collect the rent, you might be able to deduct vehicle expenses. 
4. You might not use the rental property personally. If so, you don’t need to prorate your expenses between personal and rental use.

Get help with rental income taxes

As you might imagine, you’ll need to track several details for your rental income tax reporting.

If you’re curious about how to add rental income to taxes to your return, there is tax software for rental income available. In fact, H&R Block Online and H&R Block Premium Tax Software, can help you manage your rental income tax reporting requirements as well as the rest of your tax filing.

Prefer the help of a tax pro? We’re here for you.  Make an appointment with a tax pro today.