IRS Publication 527: Rental Income, Depreciation, and Loss Limits

IRS Publication 527 is the agency’s guide to residential rental property taxes, and it walks owners through the three questions that shape every rental return: what income you have to report, what expenses you can deduct against it, and how to recover the cost of the building and its contents through depreciation. The publication itself is the starting point, but the rules it points to live in the depreciation regulations, the passive activity loss statute, and a handful of elections that can move your tax bill by thousands of dollars in either direction. The pages below pull those threads together so you can see how a rental year actually works on a return.

What Rental Income You Have to Report

Rental income is every payment you receive for the use of your property, not just the monthly rent. Advance rent is taxable in the year you receive it, even if it covers a future period. If your tenant pays one of your expenses directly, that payment is income to you. If you accept property or services instead of cash, you report the fair market value of what you received.¹

Security deposits are treated based on what you plan to do with them. A refundable deposit you expect to return at the end of the lease is not income when you receive it. A deposit designated as the tenant’s final month’s rent is advance rent and taxable right away. If you later keep part or all of a deposit to cover damage or unpaid rent, that amount becomes income in the year you keep it.²

Lease cancellation fees round out the list. If a tenant pays you to break a lease early, that payment is rental income in the year received.²

Deductible Operating Expenses

You can deduct ordinary and necessary expenses for managing, maintaining, and conserving your rental property, starting from the date you make it available for rent. Common categories include property management fees, advertising, insurance premiums, utilities you pay for tenants, property taxes, and mortgage interest. Travel to manage the property, legal and accounting fees tied to the rental activity, and pest control also qualify.¹

The test is whether the expense is both ordinary (common in the rental business) and necessary (helpful and appropriate). Personal expenses never qualify. Any expense that benefits both the rental and your personal residence has to be allocated between the two uses.

Repairs Versus Improvements

This is where most audit trouble starts. A repair keeps the property in its current working condition without adding value or extending its useful life. Fixing a leaky faucet, patching drywall, or repainting a room are repairs, deductible in full the year you pay for them. An improvement adds value, extends useful life, or adapts the property to a new use. Replacing an entire roof, installing a new HVAC system, or adding a bathroom must be capitalized and recovered through depreciation.³

The IRS Tangible Property Regulations set the framework. Any amount paid to restore, better, or adapt a “unit of property” must be capitalized. Replacing a small section of a roof is a repair; replacing the whole roof is a restoration that gets capitalized.⁴ Keep invoices that describe the work in enough detail to support your call. Vague line items like “plumbing work” invite questions from examiners.

The De Minimis Safe Harbor

You can elect to immediately deduct small purchases that might otherwise need to be capitalized. Without audited financial statements (most individual landlords don’t have them), you can expense items costing $2,500 or less per invoice or item. With an applicable financial statement, the threshold is $5,000. Make the election each year by attaching a statement to your return.⁴

The election is useful for a replacement garbage disposal, a window air conditioner, or a set of blinds. The $2,500 threshold is per item, so a $4,000 purchase doesn’t qualify even if you split the payment across two checks.

Depreciating the Building and Its Contents

Depreciation recovers the cost of your building and other capital assets over their useful lives. It is a required deduction. You cannot skip it, and the IRS will reduce your property’s basis by the amount you should have claimed whether or not you actually did. Land is never depreciable because it doesn’t wear out.⁵

Before you can start, split your purchase price between the building and the land, typically using the relative fair market values at the time of purchase. Only the building portion (plus settlement costs properly allocated to it) forms your depreciable basis.⁶

The Building: 27.5 Years, Straight Line

Under the Modified Accelerated Cost Recovery System (MACRS), residential rental buildings are depreciated over 27.5 years using the straight-line method with a mid-month convention. The property is treated as placed in service at the midpoint of the month you begin renting it, so you get a half-month’s depreciation for the first month, full months for the rest of the year, and a prorated amount in the year of disposition.⁷

Capital improvements are separate depreciable assets, each with its own 27.5-year clock starting the month it’s placed in service. A new roof installed five years after purchase gets its own 27.5-year schedule beginning when the work is completed.³

Appliances and Furnishings: 5 or 7 Years

Appliances, carpets, and furniture used inside a residential rental unit are 5-year MACRS property. Office furniture and fixtures fall into the 7-year class. These shorter recovery periods produce faster deductions than the building itself.⁵

100% Bonus Depreciation for Personal Property

The One Big Beautiful Bill Act permanently restored 100% first-year bonus depreciation for qualified property acquired and placed in service after January 19, 2025. For rental owners, that means you can deduct the full cost of appliances, carpeting, furniture, and similar personal property in the year you place it in service, rather than spreading it over five or seven years.⁸

Bonus depreciation does not apply to the residential building itself, since only property with a recovery period of 20 years or less qualifies. The 27.5-year building keeps its full schedule, but the $2,000 stove and the $1,500 refrigerator you put in it can be written off entirely in year one. Before the new law, bonus depreciation had dropped to 40% for 2025.

What Depreciation Costs You at Sale

Depreciation is a non-cash deduction. It reduces taxable income without costing you anything out of pocket in the year taken. But every dollar of depreciation claimed (or that should have been claimed) reduces your adjusted basis, which increases your taxable gain when you sell.

At sale, the gain attributable to prior depreciation is taxed as “unrecaptured Section 1250 gain” at a maximum federal rate of 25%, higher than the typical long-term capital gains rate of 15% or 20%.⁹ Say you bought a rental building for $300,000 (land excluded) and claimed $100,000 in total depreciation. Your adjusted basis is $200,000. Sell for $350,000 and you have $150,000 of gain. The first $100,000 (equal to cumulative depreciation) is taxed at up to 25%; the remaining $50,000 is taxed at the long-term capital gains rate. Recapture applies whether or not you actually benefited from the deductions at the time, which matters if passive loss rules suspended them.

A Section 1031 like-kind exchange into another qualifying real property can defer both the capital gains tax and the depreciation recapture, but only real property qualifies after the Tax Cuts and Jobs Act, and the 45-day identification and 180-day closing windows are strict.¹⁰

Passive Activity Loss Limits

Rental real estate is classified as a passive activity by default, no matter how many hours you spend on it. Rental losses can only offset income from other passive activities, not wages, salary, business income, or portfolio income like dividends and interest.¹¹

Unused losses aren’t lost. They’re suspended and carried forward indefinitely until you either generate enough passive income to absorb them or sell the property in a fully taxable transaction, at which point all accumulated suspended losses become deductible against any type of income.¹¹

The $25,000 Active Participation Allowance

If you actively participate in your rental activity, you can deduct up to $25,000 of rental losses against non-passive income like wages. Active participation is a lower bar than material participation. It means you make management decisions such as approving tenants, setting rental terms, or authorizing repairs. You don’t have to swing the hammer yourself, but you can’t be completely hands-off.¹²

The allowance phases out as your modified adjusted gross income (MAGI) rises above $100,000. For every $2 of MAGI over $100,000, you lose $1 of the allowance, so it’s gone entirely at $150,000. Married taxpayers filing separately who lived together at any point during the year get a reduced $12,500 ceiling with a $75,000 phase-out threshold.¹²

Real Estate Professional Status

Qualifying as a Real Estate Professional removes the passive label from your rental activities entirely, letting you deduct rental losses against wages and other ordinary income without the $25,000 cap or the MAGI phase-out. The bar is high. You have to meet both tests:¹³

More than half of all the personal services you perform across all trades and businesses during the year must be in real property trades or businesses where you materially participate.
You must perform more than 750 hours of service during the year in real property trades or businesses where you materially participate.

Real property trades and businesses include development, construction, acquisition, management, leasing, and brokerage. On a joint return, only one spouse’s hours count toward the two tests. In practice, this exception mainly helps taxpayers who work in real estate full-time. A surgeon who owns rentals on the side will fail the more-than-half test, no matter how many hours they log on property management, because the bulk of their services are in medicine.

The Short-Term Rental Carve-Out

If the average period of customer use is seven days or less (the norm for vacation rentals and Airbnb-style listings), the activity isn’t treated as a “rental activity” under the passive loss rules at all. It’s a regular trade or business, and if you materially participate you can potentially deduct losses against other income. The trade-off: short-term rental income may be subject to self-employment tax if you provide substantial services like daily cleaning, concierge, or meals. A hands-off platform listing where guests handle everything usually avoids self-employment tax even when it clears the seven-day hurdle.

Personal Use and Vacation Homes

When you use a rental property personally, a separate set of rules kicks in, and the treatment depends on how many days you rent versus how many days you use it yourself.

The 14-Day Rule

Rent out a dwelling you also use as a home for fewer than 15 days during the year, and none of the rental income is taxable and none of the rental expenses are deductible. It’s a full exclusion regardless of how much rent you collect. A lake house rented for two weeks at $5,000 per week produces $10,000 tax-free.¹⁴

Mixed-Use Allocation

Cross the 15-day threshold and all rental income becomes taxable, with expenses split between rental and personal use. Your property is a personal residence for tax purposes if you use it personally for more than the greater of 14 days or 10% of the days it was rented at a fair price.¹⁴

Once the personal-use thresholds are met, you allocate expenses based on the ratio of rental days to total use days. Only the rental portion is deductible, and your rental deductions generally can’t exceed rental income from the property. Mortgage interest and property taxes allocated to personal use may still be deductible on Schedule A if you itemize, subject to those separate limitations.

The 20% Qualified Business Income Deduction

Rental owners operating through a sole proprietorship, partnership, S corporation, or trust may qualify for a deduction of up to 20% of qualified business income under Section 199A. The deduction, made permanent by the One Big Beautiful Bill Act, directly reduces taxable income.¹⁵

The challenge for landlords is showing that the rental activity is a “trade or business.” The IRS provides a safe harbor: if you perform at least 250 hours of rental services per year (or in at least three of the past five years for longer-running enterprises) and keep contemporaneous records like time logs, the activity qualifies for 199A.¹⁶

Even without the safe harbor, a rental activity can qualify under general tax principles if it rises to a trade or business. The deduction is limited to the lesser of 20% of QBI or 20% of your taxable income minus net capital gains, and higher-income taxpayers face additional limitations tied to W-2 wages paid and the property’s depreciable basis.¹⁵

The Forms That Pull It All Together

Rental income, expenses, and depreciation come together on a handful of forms that attach to your individual return.

Schedule E and Form 4562

Schedule E (Form 1040), Supplemental Income and Loss, is the primary form. You report gross rental income, itemize deductible operating expenses (advertising, cleaning, repairs, insurance, management fees, taxes, and interest among them), and enter your depreciation deduction. Net profit or loss flows through to your Form 1040.¹⁷

Depreciation itself is calculated on Form 4562, Depreciation and Amortization, which documents each asset’s cost, date placed in service, recovery period, and method. The total transfers to the appropriate line of Schedule E.¹⁸

Form 8582 for Suspended Losses

If your rental produces a net loss and you’re subject to the passive activity rules, you generally need Form 8582, Passive Activity Loss Limitations. It applies the $25,000 active participation exception, tracks suspended losses carried forward, and produces the deductible loss figure for your return.¹⁹

You can skip Form 8582 if all of these are true: your only passive activities are rental real estate with active participation, you have no prior-year suspended losses, your total rental loss is $25,000 or less, and your MAGI is $100,000 or less. Meet all of them and the rental loss is fully deductible without the form.²⁰

Form 1099-NEC for Contractors

Landlords who pay contractors for services related to the rental (plumbers, electricians, property managers, landscapers) must issue Form 1099-NEC to each person paid $600 or more during the year. This covers payments to individuals and unincorporated businesses, not corporations. Missing 1099s carry penalties, and it’s one of the easier compliance items to overlook when your attention is on the income-and-expense side of the return.²¹

1
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
2
Internal Revenue Service. Topic No. 414, Rental Income and Expenses
3
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property – Section: How Do You Treat Repairs and Improvements
4
Internal Revenue Service. Tangible Property Final Regulations
5
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
6
Internal Revenue Service. Publication 551 (12/2025), Basis of Assets
7
Internal Revenue Service. Instructions for Form 4562 (2025) – Section: Part III MACRS Depreciation
8
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One Big Beautiful Bill
9
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
10
Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
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Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
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Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules – Section: Special $25,000 Allowance
13
Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
14
Internal Revenue Service. Topic No. 415, Renting Residential and Vacation Property
15
Internal Revenue Service. Qualified Business Income Deduction
16
Internal Revenue Service. IRS Finalizes Safe Harbor to Allow Rental Real Estate to Qualify as a Business for Qualified Business Income Deduction
17
Internal Revenue Service. About Schedule E (Form 1040), Supplemental Income and Loss
18
Internal Revenue Service. About Form 4562, Depreciation and Amortization (Including Information on Listed Property)
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Internal Revenue Service. About Form 8582, Passive Activity Loss Limitations
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Internal Revenue Service. 2025 Instructions for Form 8582 – Passive Activity Loss Limitations
21
Internal Revenue Service. Am I Required to File a Form 1099 or Other Information Return