BECOMING A LANDLORD
How renting out your house affects your taxes
Rent you collect is taxable income, reported on Schedule E. Against it you deduct the rental's expenses — mortgage interest, property tax, insurance, repairs, and more — plus depreciation on the building. Many first-year rentals show little or no taxable profit. The trade-off comes when you sell: depreciation is taxed then.
The first tax season after you rent out your home is usually less painful than people expect — and more confusing. Here's how it works, in the order you'll meet it.
Rent is income — but not all of it is taxed
Every dollar of rent you collect counts as rental income, including rent paid in advance and any fees the tenant pays you (a late fee, a pet fee). You report it on Schedule E (Form 1040), Part I, with one column per property.
What gets taxed isn't the rent, though. It's the rent minus the rental's expenses minus depreciation. For a lot of first-year rentals — especially ones with a mortgage — that number is small, zero, or a loss.
Two things that are not income when you receive them:
- A security deposit you plan to return. It becomes income only if you keep some of it.
- Money a tenant pays that you pass straight through for something that's their obligation — but if the tenant pays an expense that's yours (say, a repair, in exchange for a rent reduction), that counts as rent.
What you can deduct
Ordinary and necessary costs of running the rental, for the period it's a rental:
- Mortgage interest (not principal), from your Form 1098
- Property tax
- Landlord insurance premiums
- Repairs and maintenance
- Utilities you pay
- Advertising, cleaning between tenants, supplies
- Legal and tax-prep fees for the rental, property management, and rental software
- Travel to the property for rental business
Our Schedule E guide maps each of these to its line on the form, and the Schedule E organizer adds them up for you.
The year you convert: expenses are split by time. Mortgage interest and property tax for the months you lived there go on Schedule A (if you itemize); the rental months go on Schedule E.
Depreciation: the deduction people forget
The IRS lets you deduct the cost of the building (not the land) over 27.5 years. On a home with a building basis of $250,000, that's about $9,091 a year — often enough to turn a small rental profit into a paper loss.
Two things specific to converting your own home:
- Your depreciable basis is the lower of your adjusted basis (what you paid plus improvements) or the home's fair market value on the day it became a rental.
- Depreciation starts the month the home was ready and available for rent, not when you bought it.
The depreciation calculator gives you this year's amount and the full schedule. In the first year you'll also file Form 4562.
If the rental shows a loss
Rental activity is generally "passive," and passive losses normally can only offset passive income. But there's an important exception for small landlords: If you actively participate in managing a rental (approving tenants, setting rent, approving repairs), you can usually deduct up to $25,000 a year of rental losses against other income. The allowance shrinks once modified adjusted gross income passes $100,000 and is gone at $150,000.
Losses you can't use this year aren't lost — they carry forward and can be used in future years or when you sell.
Repairs vs. improvements
A repair keeps the home in working order — fixing a leak, replacing a broken window pane, patching drywall — and is deducted in the year you pay for it. An improvement makes it better, restores it, or adapts it to a new use — a new roof, a kitchen remodel, a new HVAC system — and is depreciated over time.
There's a helpful shortcut for small purchases: Under the de minimis safe harbor, you can elect to deduct items costing $2,500 or less per invoice or item in the year you buy them, instead of depreciating them.
What changes when you sell
Two things happen at sale:
- The home-sale exclusion may still apply, if you sell within the 2-of-5-year window. See the 2-out-of-5-year rule.
- Depreciation recapture. Depreciation you claimed (or could have claimed) after May 6, 1997 can't be excluded. That part of the gain is taxed when you sell, at a maximum federal rate of 25%.
Records to keep from day one
Keep records that support income and deductions for at least 3 years after you file (6 if income was underreported by more than 25%). Keep records of what you paid for the property and its improvements until the limitations period ends for the year you sell it. In practice: a folder (paper or digital) per property with the closing statement, every improvement receipt, every expense, and a ledger of rent received. It's the difference between an hour at tax time and a weekend.
Sources: IRS Publication 527, IRS Publication 925, IRS Publication 523. This is general information — a tax professional can apply it to your situation.
Common questions
Does renting out a house count as income?
Yes. Rent is taxable income, but you report it net of the rental's expenses and depreciation on Schedule E, so the taxable amount is often much smaller than the rent you collect.
Is a security deposit taxable income?
Not when you receive it, if you plan to return it. It becomes income only if you keep some or all of it — for example, to cover damage or unpaid rent.
Can a rental loss reduce my other taxes?
Often, up to a limit. If you actively participate in managing the rental, you can usually deduct up to $25,000 of rental losses a year against other income; that allowance phases out between $100,000 and $150,000 of modified adjusted gross income.
General information, not legal or tax advice. Where we state a law, we link the statute and re-check it on a schedule; your city or county can add rules of its own.