Rental income and tax in the US: what you need to know

There is no tax-free allowance for rental income in the US. Rent you receive is generally taxable and reported on Schedule E of your federal return, offset by the expenses of producing it. The complexity is not in whether it is taxable — it is in what you can deduct, how depreciation works, and how losses are treated.

What counts as rental income

Rental income includes the rent itself, advance rent (taxable in the year received, even if it covers a later period), payments a tenant makes for breaking a lease, expenses a tenant pays on your behalf, and the fair value of property or services received in lieu of rent. Security deposits are not income when received if you intend to return them — but any portion you keep becomes income in the year you keep it.

What you can deduct

• Mortgage interest on the rental property
• Property taxes and insurance
• Repairs and maintenance — but not improvements, which must be capitalized and depreciated
• Property management and leasing agent fees
• Utilities you pay
• Advertising for tenants
• Legal and professional fees relating to the rental
• Travel related to managing the property
• Depreciation of the building (not the land)

Depreciation: the part people miss

Residential rental buildings are depreciated over 27.5 years under the modified accelerated cost recovery system. Land is not depreciable, so you must allocate the purchase price between land and building. Depreciation is a real deduction that reduces taxable rental income each year — but it also reduces your basis in the property, and when you sell, the depreciation you took (or were entitled to take) is generally subject to recapture at a specific tax rate. Because the IRS treats depreciation as allowed or allowable, failing to claim it does not avoid the recapture. This is a strong argument for professional advice from the first year.

Repairs versus improvements

A repair keeps the property in ordinary operating condition — fixing a leak, repainting, replacing a broken window — and is deductible in the year you pay it. An improvement betters, restores or adapts the property — a new roof, a kitchen remodel, an addition — and must be capitalized and depreciated over years. This distinction has a large effect on your tax in any given year, and the IRS has detailed tangible property regulations governing it, including safe harbors for small amounts.

Passive activity loss rules

Rental activity is generally treated as passive, which means rental losses can usually only offset passive income rather than wages. There is a special allowance letting some taxpayers who actively participate in a rental deduct a limited amount of loss against other income, phased out above certain income levels. Real estate professionals who meet specific IRS material participation tests are treated differently. Disallowed losses are generally suspended and carried forward. These rules are among the most misunderstood in the code — check irs.gov or ask a CPA.

Renting part of your own home

If you rent a room in your own home, you must allocate expenses between personal and rental use, typically by square footage or by the number of rooms. Only the rental portion is deductible. There is also a narrow rule for very short-term rentals: if you rent a home you use as a residence for fewer than 15 days in the year, the income generally does not have to be reported at all — but no rental expenses can be deducted either.

Record keeping

Keep records of rent received, every expense with receipts, the purchase price and closing statement, the land and building allocation, and the cost of every improvement. Depreciation schedules run for decades, and the records that determine your gain on sale may be needed many years after the event. Keeping them properly from the start is far easier than reconstructing them later.