Rental Income Taxes Explained: 6 Key Questions, Answered

The money you make from your rentals is taxable income, and the rules for reporting it are more complex than many new landlords, rental property owners, and real estate investors expect. Whether you own a single residential rental property or a growing portfolio, it's important to understand the process and how to keep more of what you earn in your business.

This guide walks through the essentials, touching on what the Internal Revenue Service (IRS) considers income, which expenses reduce your tax bill, how state obligations vary, and how to prevent costly mistakes as you grow.

What Is Rental Income?

Rental income comprises four main sections: amounts paid to cancel a lease, rent paid in advance, tenant-paid expenses, and security deposits. IRS Publication 527 is the primary guidance document for rental income and expenses, including depreciation.

Money that comes from a lease cancellation is considered rental income. You need to report this for the tax year in which you received it. Advance monthly rent paid in the tax year in which it is received is also considered rental income, as well as expenses paid by tenants. However, this form of rental income may be deductible.

There are several components to security deposits:

• Security deposits that will be returned to the tenant after their lease is fulfilled do not count as rental income.

• If your tenant broke the lease early or moved out of the property early, you must include the amount of income that you kept as income for the tax year.

• If you kept part or all of the tenant's security deposit because of damaged property to make repairs, you will include the amount you kept as rental income if you deduct the cost of repairs as expenses.

• The security deposit applied to your tenant's last month of their lease is advance rent. Upon receiving the money, it can be considered rental income.

How Much Tax Do You Pay on Rental Income?

Whether you own or manage residential, commercial, or short-term rental properties (like those found on Airbnb), you are obligated to report rental income. Rental income is reported and taxed just like any other source of income. If your combined income exceeds your bracket's threshold, you will be bumped to the next tax bracket and be subject to a higher tax rate.

The tax rate on your rental income is mainly dependent on your personal income tax bracket. Review the table for the IRS’s marginal tax rate for 2026. This tax system applies different rates to sequential portions of your income. As you earn more and enter a higher bracket, only the additional money earned within that new bracket is taxed at that rate, rather than all of your income.

If you own more than three rental properties, you will file a Schedule E for each property.

In addition to understanding these tax brackets, high-income landlords should be aware of the 3.8% NIIT. This tax applies to rental income for single filers with Modified Adjusted Gross Income (MAGI) over $200,000, and $250,000 for married filing jointly. IRS Form 8960, Net Investment Income Tax Individuals, Estates, and Trusts, is used to calculate and report NIIT.

How Is Rental Income Tax Calculated?

To calculate your rental income tax, add up all the rent that you've received. Include any expenses from your property. You should also include the fair market value of any merchandise or services you received. If you are planning to return security deposits at the end of the lease, don't include that amount in your gross income total. Some rental properties do not feature a security deposit, so skip that step if your property qualifies. For example, Airbnb hosts do not typically collect a security deposit for their short-term rental properties in 2026.

Next, add the amounts of property-related costs such as advertising, depreciation, insurance, maintenance, and taxes. Finally, subtract the expenses from your gross income. This amount is your taxable income.

There are three possible results:

• For a total greater than zero, this is the amount of your taxable rental income.

• For a total that is less than zero, this is the amount that you can deduct from other income sources, such as lost business revenue.

• A total of zero doesn't affect your income.

If you sell a property, which is a depreciable asset, you might face depreciation recapture. Depreciation recapture, capped at a maximum 25% rate, requires you to pay taxes on the depreciation deductions you previously claimed when you sell a rental property for a profit. 1-800Accountant's tax advisors can help you model the tax impact before selling a property.

Is Rental Income Earned Income?

Exceptions to rental income being considered earned income

There are scenarios where your rental income is not considered earned income.

For instance, if you use a dwelling unit as your personal residence and rent it out for fewer than 15 days in a year, you do not have to report the rental income, and you cannot deduct any expenses as rental expenses. If the property serves both rental and personal use, expenses must be split between the two uses based on the number of days used for each purpose. Only the rental portion of allowable expenses can be deducted from your tax return. This is similar to how you file business and personal deductions separately.

Passive activity loss rules

Rental income is typically considered unearned income by the IRS and other tax authorities. Unlike earned income, which primarily includes wages, salaries, or business income from active participation, unearned income typically includes sources from real estate, including interest, dividends, and rental income.

Rental real estate losses are referred to as passive activity losses. While you wouldn't be able to deduct passive rental activity losses against active income, such as a salary, you can deduct these losses against other passive income, such as a second rental property that generates a profit.

Real Estate Professional Status

It's important to maintain your professional real estate status. Do this by spending 750 or more hours annually performing services in real property trades or businesses, ensuring more than 50% of the total time involved in trade or business is for real estate, and you must actively and regularly participate in the day-to-day operations of your real estate activities.

Qualifying for this status can change how income and losses are treated.

What is Tax Deductible From Rental Income?

As a landlord, there are numerous rental property tax deductions you can claim that will reduce your tax liability. These deductible expenses must be ordinary, necessary, and directly related to the management, conservation, or maintenance of your rental property.

This table lists common tax deductions related to rental income and what each covers.

Taxpayers can take advantage of several deductions to reduce their tax liability and potentially avoid paying higher taxes. Ordinary expenses include everyday payments made to maintain your property. Necessary expenses include advertising, insurance, maintenance expenses, and utility costs.

Maintenance, materials, repairs, and supplies costs are eligible for deductibles. You can also deduct expenses paid by a tenant if they are deductible rental expenses. However, you can't deduct the cost of improvements to your rental property.

How is depreciation calculated?

Depreciation for your rental property is calculated via the following steps:

• Determine your property's cost basis

• Select the recovery period (typically 27.5 years for residential rental properties)

• Choose the method of depreciation (Straight-line or MACRS)

• Apply the depreciation rate

• Calculate annual depreciation

For example, if you bought a building in January 2025 for $250,000 and placed it in service that month, that purchase price is your cost basis with a 27.5-year recovery period. Determine the annual depreciation rate (1 ÷ 27.5 = 3.636% annually) using the straight-line method for equal annual deductions, resulting in an annual depreciation of $9,090. The passage of the One Big Beautiful Bill Act permanently restored 100% bonus depreciation for eligible property placed in service after January 19, 2025.

If you intend to make repairs or improvements this year, it's important to understand the distinction. Repair costs are immediately deductible, while improvements to your rental property must be depreciated over time.

Are state taxes applicable to rental income?

State taxes generally apply to rental income, although rules can vary significantly, including for:

• Tax rates

• Allowable deductions

• Passive losses (whether they follow federal tax guidelines)

For example, because Texas doesn't have a state income tax, a landlord there wouldn't owe state income tax on the $8,000 the landlord netted that year, although other property taxes and fees may still apply. In California, by contrast, a landlord would owe state income tax on that $8,000 in net rental income.

Some states have made changes that benefit landlords, such as Arizona, which has eliminated the Transaction Privilege Tax (TPT). Since January 2025, Arizona has prohibited cities, towns, and other jurisdictions from taxing residential rental income for long-term stays of 30 consecutive days or more, including:

• TPT

• Sales

• Gross receipts

• Use

• Franchise

Staying up to date with state tax rules for rental income can be difficult without 1-800Accountant's year-round tax advisory solution.

Net Investment Income Tax and Rental Property

High-earning rental property owners (above MAGI thresholds) may also need to pay the 3.8% NIIT.

How your rental income interacts with NIIT depends on your level of participation. If your rental activity is passive, your net rental income is subject to NIIT. If you materially participate in the rental, the income is treated as non-passive trade or business income, which typically avoids NIIT. IRS Form 8960 is used to calculate and report NIIT.

If your rental activity is subject to NIIT, there are planning strategies that can reduce it. Time your income by managing MAGI limits and embracing installment sales, and use losses strategically, like offsetting capital gains by selling specific stocks or investments at a loss. This simultaneously reduces your net investment income and your overall MAGI.

Frequently Asked Questions

How does the IRS know if I have rental income?

The IRS has several ways to determine whether or not you have rental income. These methods include third-party reporting, reported income and expense discrepancies, audits and reviews, and public records. If you're unsure about your responsibilities, don't hesitate to seek advice from a real estate tax professional.

Do I pay taxes on rental income from a property in another state?

Yes, you will pay taxes on rental income from a property you own in another state. You will also need to report this income on your home-state tax return. However, your resident state typically grants a tax credit for the taxes paid to the other state to prevent double taxation.

What happens if I don’t report rental income?

It's important to report all rental property income to the IRS. Failing to report rental income during tax season can lead to hefty IRS penalties, audit risks, and compounding interest on back taxes. The IRS may also disallow all of your related rental deductions, converting the total rent collected into fully taxable income. Intentional non-reporting, which is rare, may even result in criminal tax evasion charges.

Can I deduct rental losses against my regular income?

Under normal IRS rules, rental losses are considered passive, meaning they can only be deducted against passive income. However, if you actively manage the property and your MAGI is under $150,000, you may qualify for a special allowance to deduct up to $25,000 in losses against your regular income. Unused losses are suspended and carried forward to offset future rental gains.

What is depreciation recapture, and when does it apply?

Depreciation recapture is an IRS rule that taxes the accumulated depreciation you took, or should have taken, on a rental property over the years. This tax applies when you eventually sell or dispose of the property and realize a gain. The recaptured amount is taxed at a maximum federal rate of 25%.

How do I report rental income if I use the property personally for part of the year?

If you use the property personally, you must allocate your expenses strictly based on the total days rented versus the days used for personal purposes. Any income from renting the property for fewer than 15 days in a year is entirely tax-free, but you cannot deduct any related rental expenses. If the property is rented for 15 days or more, you must report the income and deduct prorated expenses on your return.

Are short-term rental properties (Airbnb, VRBO) taxed differently?

Short-term rentals (averaging 7 days or less per guest) are generally classified as non-passive income and are subject to self-employment tax. If you provide substantial hotel-style services, such as daily cleaning and meals, the income goes to Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship), instead of Schedule E. Additionally, many municipalities require short-term rentals to collect and remit local hotel or transient occupancy taxes.

Managing Your Rental Tax Obligations Year-Round

With these six key questions answered, new rental property owners, landlords, and real estate investors now have a clearer idea of how to manage their rental income effectively throughout the year. While you can handle this work on your own, staying on top of deductions, ever-changing rules, and planning strategies is optimal with expert support.

1-800Accountant's Small Business Bundle is ready to use and includes everything your rental properties need to stay compliant, ensure tax savings year-round, and move forward with confidence in 2026.