5 Great Things to Know About Rental Income and Taxes

October 5, 2022
Main post image

Property management can be a lucrative industry for landlords. It is a fast-paced industry with many moving parts, such as interviewing potential tenants, managing current tenants, and maintaining property quality. Income tax and deductions for rental properties may not be top of mind, but there are certain things about rental income and taxes every landlord should know about.

If you’re a landlord that is earning rental income from property management, you should know about rental income tax and potential tax deductions.

1. What Is Rental Income? 

Rental income is a broad term that includes four sections:

  • Amounts paid to cancel a lease
  • Advance rent
  • Expenses paid by a tenant
  • Security deposits

First, 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 rent paid in the tax year in which you receive it is rental income. Expenses paid by tenants are also rental income; however, this form of rental income may be deductible.

There are several components to security deposits:

  • Security deposits that will be returned to your tenant after their lease does 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.

2. How Much Tax Do You Pay on Rental Income?

Rental income is reported and taxed just like any other source of income. Therefore, your tax rate on your rental income is largely dependent on your tax bracket. The IRS’s marginal rate for tax year 2002 breaks down as follows based on filed income:

  • 37% | $539,900 and up (individual) / $647,850 and up (married/joint)
  • 35% | $215,950 and up (individual) / $431,900 and up (married/joint)
  • 32% | $170,050 and up (individual) $340,100 and up (married/joint)
  • 24% | $89,075 and up (individual) / $178,150 and up  (married/joint)
  • 22% | $41,775 and up (individual) / $83,550 and up (married/joint)
  • 12% | $10,275 and up (individual) / $20,550 and up (married/joint)
  • 10% | Under $10,275 (individual) / Under $20,550 (married/joint)

Remember, if you own more than three rental properties, you will file a Schedule E (Form 1040) for each property.

3. 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.   

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.

4. Is Rental Income Considered Earned Income?

There are some exceptions where your rental income is not subject to taxation. You don’t need to report rental income or deduct any expenses if you use a dwelling unit as a residence and rent it for fewer than 15 days. 

If you use your dwelling for both rental and personal purposes, divide your total expenses between your rental and personal use based on the number of days used for each purpose. This is similar to how you file business and personal deductions separately.

5. What is Tax Deductible From Rental Income? 

There are expenses that you’ll be able to deduct from your rental income: 

  • Depreciation 
  • Operating Expenses 
  • Repair Costs

It’s possible to take advantage of several deductions to avoid paying higher taxes. Expenses such as ordinary expenses and necessary expenses can reduce your tax liability, or the amount you owe in taxes. 

Ordinary expenses include everyday payments that you make to maintain your property. Necessary expenses include advertising, insurance, maintenance expenses, and utility costs. 

Costs of maintenance, materials, repairs, and supplies 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.

Rental Income and Taxes FAQs

Do you pay taxes on rental income?

Yes. Income from rental properties should be reported on your tax return. Business-associated expenses can often be deducted from your rental income. 

Do I pay taxes on rental income from another state?

You must file a tax return in the state where your property is located, even if you maintain residence in another state. You might be required to file a 1040 or similar return type. Be sure to keep up with state and local tax laws applicable to your properties. 

What is the tax rate on rental income?

Since rental income is taxed just like any other form of income, your tax rate is dependent upon tax bracket based on annual income. Tax rates, deductions and other aspects will vary by state and other local regulations. 

How do I avoid paying tax on rental income?

Various deductions are available to lessen your financial burden when filing your tax return. Ordinary and necessary expenses for maintaining your property, material costs, and expenses paid from your tenants are a few examples of deductions to potentially include on your tax return.

Will rental income affect my taxes?

Yes. Rental income should be treated just like any other form of income when you file your tax return. If your combined incomes exceed a certain amount, you could be bumped to the next tax bracket, and be subject to a high tax rate. Consult with an experienced tax professional to ensure yours are filed properly and you get the best return available.

Work with a Professional

Potential deductions on rental income can help landlords save money by reducing tax liability. Work with an accounting professional to ensure you take advantage of as many tax deductions as possible. Don’t hesitate to seek expert advice to maximize your rental property income! 

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.