Rental Income & Expenses (2025)

Where to Report

Rental income/expenses generally go on Schedule E (Form 1040). Royalty income also on Schedule E. Exception: if providing substantial services (like a hotel — daily maid service, etc.), report on Schedule C (net profit subject to SE tax). Hotels, motels, B&Bs, and boarding houses → Schedule C.

Rental income is subject to income tax but NOT self-employment tax (unless you're a real estate professional providing substantial services).

What Counts as Rental Income

• Regular rent payments
• Advance rent (taxable in year RECEIVED, regardless of period covered)
• Lease cancellation payments (taxable in year received)
• Security deposits retained (taxable when forfeited by tenant)
• Property/services received in lieu of cash (at FMV)
• Expenses paid by tenant on your behalf (count as both income AND deductible expense)

Not taxable when received: Refundable security deposits (only if returned to tenant).

Deductible Rental Expenses

All ordinary and necessary expenses for managing, conserving, and maintaining rental property:

• Mortgage interest
• Property taxes
• Insurance premiums
• Repairs (fix leaks, repaint, replace broken windows — NOT improvements)
• Maintenance (lawn care, cleaning, snow removal)
• Utilities paid by owner
• Advertising for tenants
• Property management fees
• Depreciation
• Travel to collect rent or manage property
• Legal/accounting fees for the rental

Repairs vs. Improvements

Depreciation

Residential rental: 27.5 years (straight-line) Commercial/non-residential: 39 years (straight-line)

• Land NEVER depreciable — only the building
• Mid-month convention: Place in service = mid-month. Dispose = mid-month.
• Depreciation begins when property is "placed in service" (ready and available for rent)
• Continue depreciation during vacancies if property is available for rent
• Depreciation basis = LOWER of FMV or adjusted basis when converting personal residence to rental

Example: Building purchased $275,000 (land $120,000 = not depreciated). Building depreciable basis = $275,000. Annual depreciation = $275,000 ÷ 27.5 = $10,000. First year (placed Jan 1): ~$9,583 (11.5 months mid-month).

Mixed-Use Buildings

If ≥80% of rental income from residential units → whole building = 27.5 year residential. If <80% residential → whole building = 39 year commercial.

§179 Expensing for Rental Property

• NOT available for residential rental property
• Available for certain non-residential improvements: HVAC, roofs, fire/security systems
• Available for lodging facilities (dormitories, hostels)
• 2025 §179 limit: $2,500,000 (phaseout begins at $4,000,000; eliminated at $6,500,000)

Safe Harbors for Repairs vs. Improvements

• De minimis safe harbor: Taxpayer may expense each invoice/item of tangible property costing ≤ $2,500 in the year used/consumed (does not apply to inventory or land purchase; may apply to land improvements). Election made annually on the return.
• Small Taxpayer Safe Harbor (SHST): For building owners with unadjusted basis ≤ $1,000,000 (excl. land), may deduct annual repairs/improvements/maintenance totaling ≤ the lesser of 2% of unadjusted building basis OR $10,000.

Converting Personal Residence to Rental

• Depreciation basis = LOWER of FMV or adjusted basis at conversion date
• Expenses must be allocated between personal and rental use periods
• Property "placed in service" on conversion date
• Repairs made BEFORE placing in service (while still personal) must be capitalized into basis (not deducted) until the property is available for rent

Vacation Home Rules

If rented <15 days per year: rental income NOT taxable, no deductions (except mortgage interest/property tax on Schedule A).

If rented ≥15 days AND personal use >14 days or >10% of rental days: classified as residence. Deduct rental expenses only up to rental income (no loss allowed). Excess mortgage interest/property tax goes to Schedule A.

If rented ≥15 days AND personal use ≤14 days or ≤10%: treated as rental property. Losses may be limited by passive activity rules.

Personal use = taxpayer, owner, family member, or anyone paying <FMV. Days spent on repairs/maintenance do NOT count as personal use.

Below-Market / Non-Profit Rental

If rented to family/others below FMV with no profit motive: not treated as rental. Income reported as "other income" on Form 1040 (NOT Schedule E). Mortgage interest and property tax deductible on Schedule A (subject to 2025 SALT cap $40,000/$20,000 MFS). Cannot deduct losses/expenses exceeding rental income; unused expenses do NOT carry forward.

Passive Activity Loss Rules

Rental real estate is generally passive (regardless of owner's participation). Losses can only offset passive income, not W-2 or portfolio income. Exception: $25,000 special allowance for active participation:

• Must own ≥10% and make significant management decisions (approve tenants, set rent terms)
• Phaseout: MAGI $100,000-$150,000 (reduced $1 for every $2 over $100K); eliminated at $150,000 ($75,000 MFS who lived with spouse)
• MFS lived apart all year: special allowance capped at $12,500, MAGI ≤$50,000
• MFS lived with spouse at any time: cannot use passive rental loss to offset non-passive income
• Disallowed losses carry forward indefinitely; released when income drops below threshold OR property sold in a fully taxable sale
• Limited partners, <10% owners, trusts/corps (except grantor trusts) cannot use the special allowance

Real Estate Professional (REP)

To qualify as a real estate professional (treats rental losses as non-passive):

• 50% of personal services in real property trades/businesses, AND

• 750 hours/year in real property trades/businesses (development, renovation, construction, acquisition, conversion, leasing, operating, management, brokerage), AND

• 5% ownership in each activity

For MFJ: one spouse must independently meet the 750-hour + >50% tests (spouse's hours count for material participation determination). REP providing only basic services reports on Schedule E (no SE tax). REP providing substantial services (daily maid, etc.) reports on Schedule C (SE tax applies).

Personal Property Rentals & Royalties

• Personal property rentals (vehicles, equipment, formal wear): NOT on Schedule E. If a trade/business → Schedule C. If not a business but profit-motivated → income on Schedule 1 Line 8l, expenses on Line 24b.
• Royalties: generally Schedule E (no SE tax). BUT if the taxpayer actively created the intellectual property (self-employed writer, musician, inventor) → Schedule C, net profit subject to SE tax (self-created copyright is NOT a capital asset in creator's hands). An heir who inherited the IP reports royalties on Schedule E with no SE tax (inherited IP IS a capital asset). Natural-resource royalties based on extracted resource value. Form 1099-MISC issued if ≥$10/year paid.