Yes, rental income is included in your adjusted gross income, but only after expenses. The IRS taxes the net figure from your rental activity, not the gross rent you collect. You subtract depreciation, mortgage interest, property taxes, repairs, insurance, and other allowable costs on Schedule E, and the resulting profit (or an allowable loss) flows through Schedule 1 into the total income and AGI lines of Form 1040. Several rules can shrink that number, block a loss from reducing AGI at all, or in one specific case keep the rent off your return entirely.
What Counts as Rent Before Any Deductions
Gross rental income is more than the monthly check. Advance rent counts in the year received, no matter what period it covers. A payment from a tenant to cancel a lease early is rent. A security deposit becomes rent only if you keep part or all of it because the tenant broke the lease; a deposit you plan to return stays off the return. If a tenant gives you services or property instead of cash, you include the fair market value of what you received.1Internal Revenue Service. Publication 527 (2025), Residential Rental Property
That gross figure is the starting point on Schedule E. It is not the number that reaches AGI.2Internal Revenue Service. Adjusted Gross Income
The Deductions That Shrink Rent Before It Reaches AGI
The gap between rent collected and the amount that lands in AGI can be large, and depreciation does most of the work.
Depreciation
Residential rental buildings are depreciated over 27.5 years, straight-line, with a mid-month convention in the first and last year of service. Land is not depreciable.3Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System On a $300,000 building, the annual deduction runs roughly $10,909. No cash leaves your pocket for that deduction, but it reduces net rental income and therefore AGI.
Repairs Versus Improvements
A repair keeps the property working as it already does: a leaky faucet, patched drywall, a replaced window. You deduct the full cost in the year paid. An improvement adds value, adapts the property to a new use, or significantly extends its life: a new roof, an added bathroom, a full kitchen remodel. Improvements are capitalized and depreciated.4Internal Revenue Service. Tangible Property Final Regulations
For smaller purchases in the gray zone, the de minimis safe harbor lets you deduct items costing $2,500 or less per invoice (or $5,000 with audited financial statements) without having to classify them. You elect the safe harbor annually on your return.4Internal Revenue Service. Tangible Property Final Regulations
Mortgage Interest, Property Taxes, and Operating Costs
Mortgage interest on a loan used to buy or improve the rental is fully deductible against rental income, with no cap like the one on a personal residence. Property taxes are fully deductible in the year paid.1Internal Revenue Service. Publication 527 (2025), Residential Rental Property Other common deductions include property management fees, insurance premiums, utilities the owner pays, advertising and listing costs, legal and professional fees, and mileage driven for management or maintenance.
All of these reduce net rental income before any of it touches AGI.
When None of the Rent Enters AGI: The 14-Day Rule
If you rent a property that you also use as a residence for fewer than 15 days during the year, you do not report the rental income at all. It is excluded from gross income and never reaches AGI. In exchange, you cannot deduct any rental expenses tied to those days.5Office of the Law Revision Counsel. 26 USC 280A – Disallowance of Certain Expenses in Connection With Business Use of Home, Rental of Vacation Homes, Etc. There is no cap on the rent charged for those days.
Mixed-Use Properties Cannot Usually Produce a Loss
A property is treated as your residence rather than a pure rental if your personal use exceeds the greater of 14 days or 10% of the days rented at fair market value.5Office of the Law Revision Counsel. 26 USC 280A – Disallowance of Certain Expenses in Connection With Business Use of Home, Rental of Vacation Homes, Etc. Once a property crosses that line, expenses must be split between rental and personal days, and the rental portion of expenses cannot exceed gross rental income after the rental share of mortgage interest and property taxes. That ceiling means a mixed-use property generally cannot generate a net loss to offset other income. Unused expenses carry forward, subject to the same limit.6Internal Revenue Service. Topic No. 415 – Renting Residential and Vacation Property
The personal share of mortgage interest and property taxes may still be deductible on Schedule A if you itemize, but that is a separate calculation from the Schedule E figure that reaches AGI.
Passive Activity Loss Rules: Why a Paper Loss May Not Reduce AGI
Rental activities are treated as passive by default, regardless of how many hours you put in. Passive losses can only offset passive income, such as profits from another rental. A rental loss cannot automatically wipe out wages or business income on your return.7Office of the Law Revision Counsel. 26 U.S. Code 469 – Passive Activity Losses and Credits Limited Losses you cannot use are suspended and carry forward until you either produce enough passive income or sell the property.
Two exceptions matter.
The $25,000 Active Participation Allowance
If you actively participate in managing the rental (approving tenants, setting rents, authorizing repairs), you can deduct up to $25,000 in net rental losses against non-passive income. The allowance phases out as AGI rises: it drops by $1 for every $2 that AGI (figured without the rental loss) exceeds $100,000, and it disappears at $150,000. Married taxpayers filing separately who lived with a spouse at any point during the year get zero.8Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
Real Estate Professional Status
If you qualify as a real estate professional, your rentals are no longer automatically passive, and the full loss can offset any income. You have to meet both tests in the same year: more than half of your working time in real property trades or businesses in which you materially participate, and more than 750 hours in those activities.7Office of the Law Revision Counsel. 26 U.S. Code 469 – Passive Activity Losses and Credits Limited For anyone holding a full-time job outside real estate, the first test is very hard to meet. On a joint return, only one spouse has to qualify, and hours cannot be combined across spouses. The IRS looks closely at these claims, and vague time records routinely fail in audits.
Short-Term Rentals With Substantial Services Skip Schedule E
If you provide substantial services primarily for tenant convenience (daily cleaning, meals, concierge, guided tours), the IRS treats the activity as a business. You report the income on Schedule C, and it is subject to self-employment tax on top of income tax.9Internal Revenue Service. Topic No. 414 – Rental Income and Expenses Schedule C income is not automatically passive, so losses can offset other income, but the 15.3% self-employment tax applies to net profit. Simply renting a furnished property without hotel-style services stays on Schedule E.
What Happens to AGI When You Sell
Depreciation reduces AGI each year of ownership, but the IRS collects on that benefit at sale. Any gain attributable to depreciation you claimed (or were allowed to claim) is unrecaptured Section 1250 gain, taxed at a maximum federal rate of 25%.10Office of the Law Revision Counsel. 26 USC 1 – Tax Imposed Gain above that portion is taxed at long-term capital gains rates of 0%, 15%, or 20% depending on taxable income. Recapture applies whether or not you actually took the deductions, so skipping depreciation each year does not avoid the tax at sale; it just wastes the annual AGI reduction. A 1031 like-kind exchange can defer both the gain and the recapture.
Extra Taxes and Deductions Tied to That AGI Figure
Once rental income lands in AGI, two more provisions can affect the outcome.
The 3.8% net investment income tax applies to passive rental income when modified AGI exceeds $200,000 (single) or $250,000 (married filing jointly). The surtax is charged on the lesser of net investment income or the amount MAGI exceeds the threshold.11Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax Real estate professional status can remove rental income from this calculation because the activity would no longer be passive.
The Section 199A qualified business income deduction can then let you deduct up to 20% of rental income that rises to the level of a trade or business. This deduction sits below the line, so it reduces taxable income rather than AGI, but it does reduce the tax you actually pay on rental profits. The IRS safe harbor requires 250 hours of rental services per year (or in three of the past five years for properties held longer than four years), separate books and records, and contemporaneous time logs.12Internal Revenue Service. IRS Finalizes Safe Harbor to Allow Rental Real Estate to Qualify as a Business for Qualified Business Income Deduction
The Path From Rent Check to Line 11
Each property gets its own column on Schedule E, Part I: address, days rented and personally used, gross rents, and each expense category. The result is a per-property net.13Internal Revenue Service. IRS Form 1040 Schedule E – Supplemental Income and Loss
If deductions produce a loss, Form 8582 calculates how much of the loss the passive activity rules let you use this year. Before that, the at-risk limits of Section 465 apply first: you cannot deduct losses beyond the cash you put in plus debt you are personally liable for.14Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
The allowable net moves to Schedule 1, then into total income on Form 1040 line 8, and finally into AGI on line 11.2Internal Revenue Service. Adjusted Gross Income That AGI figure then drives modified AGI, which the IRS uses for phaseouts on credits like the Child Tax Credit and for Roth IRA contribution eligibility. So a rental that shows a small net profit, or an allowable loss, changes far more than the tax on the rent itself.