Do You Have to Pay Tax on Rent? Deductions, Depreciation, and 1031s

Yes, you have to pay tax on rental income. The IRS treats rent you collect as ordinary income, taxed at the same marginal rate as your wages, and you report it on Schedule E of Form 1040. The tax on rental income you actually owe is almost never calculated on the gross rent, though. You subtract mortgage interest, depreciation, repairs, insurance, property taxes, and other allowable expenses first, and only the net figure flows into your taxable income. For many landlords, deductions and depreciation shrink that net figure to a small fraction of what tenants paid.

What Counts as Rental Income

Rental income is broader than the monthly rent check. It includes every payment you actually or constructively receive from a tenant for the use of your property.¹

Advance rent is fully taxable in the year you receive it, even if the payment covers a future lease period.² A tenant who pays three months up front in December for January through March gives you three months of taxable income for the current year.

Security deposits work differently. You don’t report a deposit as income when you receive it, as long as you plan to return it. The moment you keep any part of it, because the tenant broke the lease, missed rent, or damaged the property, that portion becomes taxable income for the year you keep it.¹

Tenant-paid expenses also count. If a tenant covers the water bill or pays a property tax assessment directly, those amounts belong in your gross rental income. You can then deduct the same amounts as expenses, so the net effect is usually a wash, but both sides need to appear on Schedule E.²

Deductions That Cut Your Taxable Rent

Every ordinary and necessary cost of operating the rental is deductible on Schedule E, reducing taxable rental income dollar for dollar.³

Operating Costs

The day-to-day costs of being a landlord come off in the year you pay them: property management fees, advertising when you’re looking for tenants, legal and accounting fees, property taxes, and insurance premiums for hazard, liability, or flood coverage. If you prepay a multi-year insurance policy, you can only deduct the portion that applies to the current tax year.²

Mortgage Interest and Depreciation

Mortgage interest on debt used to buy or improve the property is usually the single largest deduction landlords claim. It goes on Schedule E, so it doesn’t compete with your standard deduction.

Depreciation is the other heavyweight. It lets you deduct a portion of the building’s cost each year as a non-cash expense, reflecting gradual wear on the structure. Residential rental buildings depreciate over 27.5 years on the straight-line method, meaning an equal fraction of the building’s value comes off every year.⁴ Only the building qualifies. Land doesn’t wear out, so you need to allocate your purchase price between the two before you start depreciating.

Repairs vs. Capital Improvements

This line trips up a lot of landlords. A repair keeps the property in its current working condition, like fixing a leaky faucet or patching drywall, and you deduct the full cost the year you pay for it. A capital improvement adds value, extends the property’s life, or adapts it to a new use, like replacing an entire roof or installing a new HVAC system. Improvements must be capitalized and depreciated, typically over 27.5 years for anything structural or 15 years for land improvements like fences and sidewalks.⁴ The IRS example: patching a small section of roof is a deductible repair, but replacing the whole roof is a capital improvement.²

Travel and Mileage

Trips to the property for maintenance, tenant meetings, or rent collection are deductible. For 2026, the IRS standard mileage rate is 72.5 cents per mile for business use of a vehicle.⁵ You can use the flat rate or track actual vehicle expenses, but you need a mileage log either way. Longer trips away from home are deductible when the primary purpose is managing the rental; mix in personal activities and you have to allocate.²

Bonus Depreciation

The One, Big, Beautiful Bill permanently restored 100% bonus depreciation for qualifying property acquired after January 19, 2025.⁶ It applies to tangible personal property with a recovery period of 20 years or less, which for landlords means items like appliances, carpeting, furniture, and certain qualified interior improvements. The residential building itself is still 27.5-year property and does not qualify.

The 20% Qualified Business Income Deduction

Landlords who operate their rentals as a trade or business may qualify for a 20% deduction on qualified business income under Section 199A. This deduction was originally set to expire after 2025 and has been made permanent. At the top marginal rate the 20% write-down is real money.⁷

The catch is proving the activity qualifies as a business. The IRS provides a safe harbor: perform at least 250 hours of rental services per year and keep contemporaneous records of what was done, when, and by whom, and your rental enterprise is treated as a trade or business for QBI purposes.⁸ Rental services include tenant screening, lease negotiation, maintenance, and rent collection, and hours worked by employees or contractors you hire count toward the total. Even without the safe harbor, you can still qualify if the activity independently rises to a trade or business.

When a Rental Loss Won’t Cut Your Other Taxes

Here is where most landlords hit a wall. Under Section 469, rental activities are generally classified as passive. If your deductions exceed your rental income and produce a loss, you can only use that loss to offset income from other passive activities.⁹ You can’t use a rental loss to reduce wages or investment income unless you meet one of two exceptions.

The $25,000 Active Participation Exception

If you actively participate in managing the property, you can deduct up to $25,000 of passive rental losses against non-passive income each year. Active participation is a lower bar than it sounds; making management decisions about tenants, lease terms, and repairs generally qualifies. The $25,000 allowance phases out by 50 cents for every dollar your adjusted gross income exceeds $100,000, and disappears entirely at $150,000 AGI.⁹

Real Estate Professional Status

The more powerful exception is qualifying as a real estate professional, which strips the passive classification off your rentals entirely. You then deduct rental losses against any income without limit. To qualify, you must spend more than 750 hours per year in real property businesses where you materially participate, and more than half of your total working hours must go to those real property activities.⁹ Realistic for full-time developers, property managers, and real estate agents who own rentals. Almost impossible if you also hold a full-time job in another field.

Losses you can’t use in the current year aren’t lost. They carry forward against future passive income, and you can deduct them fully when you sell the property in a taxable transaction.

Short-Term Rentals Follow Different Rules

Vacation rentals booked through Airbnb, VRBO, and similar platforms don’t play by the standard passive activity rules.

If the average guest stay is seven days or less, the IRS does not treat the activity as a “rental” under the passive activity rules.¹⁰ It’s a trade or business, so losses aren’t automatically passive and can offset your other income if you materially participate. The flip side is that reclassification may drag in self-employment tax.

Self-Employment Tax

Long-term rental income is generally excluded from self-employment tax by federal law.¹¹ Short-term rentals where you provide significant services to guests, like daily cleaning, meals, or concierge-style amenities, can lose that exclusion. When that happens, net rental profit is subject to the 15.3% self-employment tax rate: 12.4% Social Security plus 2.9% Medicare.¹² The Social Security portion applies to your first $184,500 of combined self-employment and wage income in 2026.¹³ Net self-employment earnings of $400 or more trigger the obligation to file Schedule SE.

Personal Use and the 14-Day Rules

If you also use a rental property personally, the IRS counts your days. You’re treated as using the property as a residence if personal use exceeds the greater of 14 days or 10% of the days it’s rented at a fair price.¹⁴ Cross that threshold and your deductible expenses cap out at your gross rental income, which means no loss.

There’s also a complete exclusion that surprises many homeowners. If you rent out your property for fewer than 15 days during the entire year, you don’t report the rental income and you don’t deduct any rental expenses. The money is tax-free.²

Renting Below Fair Market Value

Charging a family member or friend a discount rate creates a tax trap. Any day the property is used by someone paying less than fair rental price counts as a personal use day.¹⁴ If those days push you over the personal use threshold, deductions get limited to rental income collected, wiping out any tax loss.

The 3.8% Net Investment Income Tax

Higher-income landlords face an extra layer of federal tax. A 3.8% surtax applies to net investment income, which expressly includes rents, when your modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married filing jointly.¹⁵ The tax is calculated on the lesser of your net investment income or the amount by which your MAGI exceeds the threshold.¹⁶

Rental deductions reduce the net investment income figure too, so maximizing expenses matters here just as it does for regular income tax. Taxpayers who qualify as real estate professionals and materially participate in their rentals may be able to exclude that income from the NIIT calculation entirely, since it would then come from a non-passive trade or business.

What Happens When You Sell

Selling a rental triggers two separate tax events that can push your bill well past the expected capital gains figure.

Depreciation Recapture

Every dollar of depreciation you claimed, or should have claimed, gets “recaptured” at sale. This portion of the gain, called unrecaptured Section 1250 gain, is taxed at a maximum federal rate of 25%, higher than the long-term capital gains rate most investors pay.¹⁷ Any remaining profit is taxed at the long-term capital gains rate of 0%, 15%, or 20% depending on your income. NIIT can apply on top of both amounts for high earners.

Recapture is unavoidable in a practical sense. The IRS calculates it based on the depreciation you were allowed to take, whether you actually claimed it or not. Skipping depreciation during ownership doesn’t save you at sale.

Deferring Gain With a 1031 Exchange

A 1031 like-kind exchange lets you defer both the capital gains tax and the depreciation recapture by reinvesting the proceeds into another investment property. Both properties must be held for business or investment use; personal residences don’t qualify.¹⁸

Two deadlines are absolute and can’t be extended except for presidentially declared disasters:

You must identify potential replacement properties in writing within 45 days of selling the relinquished property.
You must close on the replacement property within 180 days of the sale or by the due date of your tax return for that year, whichever comes first.

Taking control of the sale proceeds before the exchange is complete disqualifies the transaction and makes all gain immediately taxable.¹⁸ A qualified intermediary must hold the funds between closings.

Estimated Payments and Records

Rental income doesn’t have withholding, so you pay throughout the year. If you expect to owe $1,000 or more in federal tax when you file, the IRS requires quarterly estimated payments. Missing them triggers an underpayment penalty even if you pay in full by April.¹⁹ You generally avoid the penalty by paying at least 90% of the current year’s tax or 100% of the prior year’s tax through withholding and estimates combined.

Keep thorough records. The IRS advises holding onto property-related records until the statute of limitations expires for the year you dispose of the property, because your depreciation basis and capital improvements affect gain at sale.²⁰ In practice: keep receipts, bank statements, and mileage logs for as long as you own the property and at least three years after filing the return that reports the sale. Keep income and expense records for each property separately.

Penalties for Not Reporting

The IRS has multiple ways to discover unreported rental income, including 1099 forms from property management companies and booking platforms. The accuracy-related penalty for negligence or substantial understatement of income is 20% of the underpaid tax.²¹ Interest accrues on both the unpaid tax and the penalty from the original due date.

The audit window is usually three years from filing. It extends to six years if you underreport total income by more than 25%. There is no time limit if you file a fraudulent return or fail to file at all.²² Unreported rental income is exactly the omission that stretches those windows.

State and Local Taxes

Federal tax is only part of the picture. Most states treat rental income as ordinary income and tax it at their standard rates, running from zero in states with no income tax to above 13% at the highest brackets. Some states add local income taxes on top. No special federal or state carve-out shelters rental income from state taxation.

Short-term rentals face additional costs. Many cities and counties impose occupancy, lodging, or hotel taxes on stays under 30 days. These are paid by the guest and collected by the host or booking platform, and combined state and local rates can exceed 15% in some jurisdictions. If you operate a short-term rental, check whether your local government requires you to register, collect the tax, and remit it directly.

1
Internal Revenue Service. Topic No. 414, Rental Income and Expenses
2
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
3
Internal Revenue Service. 2025 Instructions for Schedule E (Form 1040)
4
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
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Internal Revenue Service. IRS Sets 2026 Business Standard Mileage Rate at 72.5 Cents Per Mile, Up 2.5 Cents
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Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill
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Internal Revenue Service. Qualified Business Income Deduction
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Internal Revenue Service. Revenue Procedure 2019-38
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Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
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eCFR. 26 CFR 1.469-1T – General Rules (Temporary)
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Office of the Law Revision Counsel. 26 USC 1402 – Definitions
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Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes)
13
Social Security Administration. What Is the Current Maximum Amount of Taxable Earnings for Social Security
14
Internal Revenue Service. Topic No. 415, Renting Residential and Vacation Property
15
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
16
Internal Revenue Service. Net Investment Income Tax
17
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
18
Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
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Internal Revenue Service. Estimated Taxes
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Internal Revenue Service. Topic No. 305, Recordkeeping
21
Internal Revenue Service. Accuracy-Related Penalty
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Internal Revenue Service. Time IRS Can Assess Tax