Rental Property Tax Guide: Deductions, Depreciation, and Reporting

How Rental Income Is Taxed

Rental income is reported on Schedule E and is generally considered passive income. All rental income must be reported, including rent payments, advance rent, security deposits you keep, and services received in lieu of rent.

Deductible Rental Expenses

Operating Expenses

Mortgage interest

Property taxes

Insurance premiums

Property management fees

Repairs and maintenance

Utilities (if you pay them)

Advertising for tenants

Legal and professional fees

Travel to the rental property

Depreciation

Residential rental property is depreciated over 27.5 years using the straight-line method. The cost of the building (not land) is divided by 27.5 to determine your annual depreciation deduction.

Example: You purchase a rental property for $300,000. The land is valued at $60,000 and the building at $240,000.

Annual depreciation: $240,000 / 27.5 = $8,727

This $8,727 deduction reduces your taxable rental income each year without any cash outflow.

Repairs vs Improvements

This distinction matters significantly:

Repairs (fully deductible in the current year): Fixing a leaky faucet, patching drywall, replacing a broken window

Improvements (must be depreciated): New roof, kitchen renovation, adding a room, replacing entire HVAC system

The IRS looks at whether the expense restores, adapts, or betters the property. If it does, it is likely an improvement that must be capitalized and depreciated.

Passive Activity Rules

Rental activities are generally passive, meaning losses can only offset other passive income. However, there is an important exception:

Active Participation Exception

If you actively participate in managing your rental (approve tenants, set rent, authorize repairs), you can deduct up to $25,000 in rental losses against non-passive income if your modified AGI is below $100,000. This benefit phases out between $100,000 and $150,000 AGI.

Real Estate Professional Status

If you spend more than 750 hours per year and more than half your working time in real estate activities, you can treat rental activities as non-passive. This allows unlimited rental losses against other income, which is extremely valuable for high earners.

When You Sell the Property

Depreciation Recapture

When you sell a rental property, previously claimed depreciation is recaptured and taxed at a maximum rate of 25%. This is in addition to capital gains tax on any appreciation.

1031 Exchange

Defer capital gains by exchanging your rental property for a like-kind property. You must identify a replacement property within 45 days and complete the exchange within 180 days.

Calculating Gain

Sale price - Adjusted basis = Capital gain

Adjusted basis = Original cost + Improvements - Accumulated depreciation

Record Keeping for Landlords

Maintain organized records for:

All income received with dates and sources

Every expense with receipts

Depreciation schedules

Improvement costs with dates and descriptions

Mileage logs for property visits

Lease agreements and tenant correspondence

Taxation.ai for Landlords

Taxation.ai automatically calculates depreciation, categorizes repairs vs improvements, tracks rental income and expenses, and generates Schedule E. The AI identifies opportunities to maximize deductions and alerts you to passive activity limitations.