Rent money typically changes hands from tenant to landlord without taxation, but does that mean it is not taxable? No, it does not. When owning and renting properties generates income, you are responsible for paying taxes on that money!
How rental income is taxed is something every landlord needs to have a good grasp on. Misconceptions about what you will owe can lead you to be strapped to make the payment or in trouble if you don’t file properly.
Having a good understanding of what is taxable rental income, how you can calculate what you’ll owe, and how to report your taxes will set you up for success. Rather than being stuck paying more than you expected to owe, you can approach tax season with confidence and certainty.
It’s time for landlords like you to learn more about how rental income taxation works. Don’t let the stress of tax season overwhelm you. Today, our landlord fact sheet will help you learn more about this essential part of your financial management process!
A Table Of Contents On How Rental Income Is Taxed
Don’t let your fears get the best of you and overcomplicate your taxes. Take a deep breath and settle in with this guide that covers the foundations of rental income and how it is taxed.
- How Does Rental Property Income Get Taxed?
- Remember: Rental Property Income Tax Rules Vary
- How To Report Tax On Rental Income
- Rental Property Tax Deductions For Landlords
- FAQs: Tax On Rental Income
How Does Rental Property Income Get Taxed?
Before you can start calculating your rental income taxes, you need to know how rental income is taxed.
What Rental Income Is Taxable?
As a property owner, all rental income you receive is taxable, and all rental income must be reported when you do your taxes. There are, of course, some things that can be deducted as expenses, but the base amount of money you receive as rent must be recorded and reported properly.
Rental income generally includes the following:
- Rent payments
- Security deposits
- Leasing fees
- Any other cash flow from the property
Most of the time, landlords will only need to think about rent payments, but security deposits and first/last month’s rent are also important to consider.
One type of rental income you may encounter is advance rent payments. If you have tenants pay first or last month’s rent when they move in, that rent payment is immediately taxable for that year’s taxes. Even if that rent is not technically owed for one or two years, it should be reported the year it is received.
This is where security deposits may come into play as well. If the security deposit is going to be used in lieu of the tenant paying their last month’s rent, it must be counted as rental income at the time the security deposit is collected as it is a type of advance rent payment. Otherwise, the security deposit does not need to be taxed as rental income.
If you end up keeping the security deposit to cover damages, the amount you keep should also be added in as taxable rental income for that year. This should be easily counteracted by adding the same amount into your expenses when repairing the damages.
What Year Should Rental Income Be Reported?
As mentioned above, rental income must be reported on your tax return for the year it was actually received, regardless of when it covers the rent.
For example, imagine a tenant who pays you in December for their January rent. The money is received by you in December, so it should be included on that year’s tax return, not the next year. Even if you do not cash the check right away, you must consider it received once it is given to you.
For more information on how to report rental tax, including questions around rental income and deductions, check out this exclusive interview with tax expert, Mark Kohler:
Remember: Rental Property Income Tax Rules Vary
An important factor to keep in mind as you work through your rental property income taxes is that income tax rules can vary from year to year and from location to location. Most of what is covered in today’s fact sheet is based on federal rules, but the specific rules you may need to follow can vary.
It is important to always confirm that you are following the proper regulations for where you do business. The best way to do this is to work with a local tax preparer to confirm your paperwork is all in order. You can also do additional research yourself, but having help from an expert is well-rewarded when it comes to taxes.
Tax Rate: Passive Or Active?
The applicable tax rate on your rental income will also depend on whether your rental business is a passive or non-passive entity in the eyes of a tax collecting agency. If you are an active participant rather than a passive one, you may have varying tax rates or sets of deductions depending on your exact role.
Double-check this as you are setting up your tax return to ensure you are properly categorized.
How To Report Tax On Rental Income
Now that you know more about how rental income tax works, let’s get into more about how you should go about gathering your information and reporting for your taxes.
Preparations
Before tax season even begins, you should get into the practice of making sure you regularly update your records with all of the rental income that you receive. Remember, that includes the following:
- Rent payments
- Security deposits if they will be used to cover rent
- Withheld security deposits used to cover damages
- Advance rent payments
If your files are up-to-date all the time, sitting down to prepare your taxes when tax season rolls around won’t be as overwhelming.
If you haven’t done this for the upcoming tax season, however, don’t panic! You can easily recall this information through your bank accounts, receipts, and other documentation. Dedicate a few hours to gathering and organizing this information so you can prepare your taxes with confidence.
The 1040 Form
The first form you will need to fill out and submit is Form 1040. The 1040 is the basic personal income tax form everyone who files federal taxes needs to fill out. To fill out this form in its entirety, you will need to be prepared with personal information such as your:
- SSN
- Dependants and related information
- Earnings information
Depending on your exact situation, you may be responsible for adding additional information or forms unrelated to your rental business. This cannot be determined on the basis of being a landlord and instead is dependent on other factors.
Schedule E
The next forms you will be working with to file your income taxes are Schedule E papers. Schedule E, also known as the Supplemental Income and Loss form, is used to report income or loss from the following:
- Reported income or loss from rentals
- Royalties
- Partnerships and S corporations
- Estates and trusts
Landlords will need to use Schedule E to report their rental earnings. This form will help you to do the necessary work to report your rental income, expenses, and even the depreciation of your rental properties to ensure you file properly.
You will need to fill out a Schedule E for each property you own if you are reporting for more than three properties. Landlords with four or more properties can do that by:
- Filling out one Schedule E form for up to three properties completely.
- Use additional Schedule E forms to list the rest of your properties in lines 1 and 2; you can use as many as needed.
- Only fill out the totals line one of the Schedule E forms that you file; totals should be the totals of all of your Schedule E forms.
If you are using tax software to help prepare your tax return, it is likely that this will all be auto-filled as you enter your information. However, it is good practice to understand the process behind this so you have a better grasp of what is going into your tax return documentation.
As always, remember that filing your income taxes is a personal process that can have a lot of variation depending on your circumstances. While the information we provide here is as accurate and complete as possible, it is always good to review your tax return with a professional if possible to ensure you are not missing out on anything.
Rental Property Tax Deductions For Landlords
Landlords need to be up-to-date about the latest rental property tax deductions that they can claim as well! Your deductible expenses are important to balancing your profit model, and they play a large factor in minimizing your tax responsibility.
There are many potential tax-deductible expenses to be aware of; these are some of the most commonly seen in the rental industry:
- Advertising costs
- Upkeep, maintenance, and cleaning
- Commissions paid to agents
- Property depreciation
- Depreciation of any capitalized improvements
- Property fees, such as condo fees
- Insurance premiums
- Local property taxes
- Equipment rental
- Repairs
- Travel expenses
- Pest control
- Professional service fees
All deductible expenses must be properly documented so you can prove that the write-off is reasonable and necessary if needed. Be sure to hang on to bank statements and receipts to be able to do this.
FAQs: Tax On Rental Income
What Happens If You Don’t Report Rental Income?
Not reporting your rental income is never a good idea! Even if you ultimately faced a loss on your rental properties, you must report your income and losses completely. If you do not, you could face serious problems. At the very least, you’ll have to pay fines. At most, you could face prison time.
Is Rental Income Taxed Differently Than Earned Income?
How does rental property income get taxed in comparison to earned income? The tax rate that is applied to your earned income is likely to be higher than your rental income, but the situation varies. Your earned income is taxed at your marginal tax rate while rental income is taxed based on your Schedule E incomes and losses.
Is Renting A Room Taxable Income?
Yes; the income generated from renting a room in your house is taxable income. That means it must be reported on your tax return. That being said, the tax deductions and write-offs that you may be eligible for could offset any tax burden.
Is A Landlord Considered Self-Employed?
Rental income is not considered to be self-employment income for federal tax purposes. Rental income is considered, in most cases, to be a passive income. This means it can only be used to offset other passive incomes and losses on Schedule E. Self-employment income, on the other hand, is calculated and taxed based on Schedule C.
Tackle Your Taxes Head On
You have learned a lot about how rental income is taxed, what is considered taxable income, and a number of other important tax factors. It can take a lot of time to carefully prepare your tax reports, but the time investment is very important for your business.
Filing an accurate tax return is important for your own personal finances. Additionally, calculating your rental income for taxes can give you a good wealth of knowledge about areas where your business could be improved in the future.
Don’t forget:
- Check your local and state laws before filing those tax returns to be as accurate as possible.
- Every situation varies depending on your unique situation and setup; be sure to look over things thoroughly.
- Don’t miss out on deductions; you deserve to balance out your income with your expenses.
Taxes don’t need to be a terrifying thing to handle, but you do need to take them seriously. With today’s fact sheet, you can do just that! For more advice on managing your rental business from tenant selection to taxes, sign up to enjoy more free landlord resources from RentPrep.