IRS Rules for Rental Property

Staying compliant with IRS rules for rental property is a non-negotiable piece of the landlord puzzle.

As we all know, Uncle Sam expects full transparency from taxpayers, and numbers that don’t add up can lead to audits, penalties, and even time behind bars.

In this article, we’ll explain everything you need to know about rental income, deductions, depreciation, passive losses, essential tax forms, and common mistakes hard-working landlords like you should avoid.

Stay tuned to learn how to dial in your accounting and bookkeeping and avoid trouble during tax season.

Reporting Rental Income to the IRS

The IRS expects landlords to report all rental income, even money earned from informal agreements or short-term bookings. Failure to report accurately can trigger IRS audits and expose landlords to penalties.

Whether you manage one unit or 100, keeping your accounting and bookkeeping on the straight and narrow is essential. With solid organizational practices, you’ll make it easier to categorize income sources, make accurate deductions, and avoid scrambling to find lost invoices come tax time.

Use the Cash Basis Method (Most Commonly Among Landlords)

Most landlords use the cash basis method to report rental income to the IRS, which means reporting earnings in the year they receive them, not necessarily the year they generate them.

Using the cash basis simplifies timing, as well. Landlords simply need to report income when they receive it. However, those who use the less popular accrual method must report based on when they actually earn the income, and not when a tenant finally gets around to paying them.

Understand What the IRS Counts as Rental Income

For better or worse, rental income includes more than the rent you receive from your tenants. As such, you must also report the following types of rental income to the IRS:

• Monthly rent
• Advance rent
• Nonrefundable security deposits
• Lease cancellation fees
• Tenant-paid expenses
• Bartered services completed in lieu of rent
• And more

When in doubt about money you’ve received related to a rental, play by this rule: If it benefits you, the landlord, or your property, declare it as rental income.

Short-Term Rental Platforms

If you make money through rental platforms like Airbnb or Vrbo, the IRS will tax every penny you earn. Why? Because these companies will treat you as a private contractor and directly report your earnings to the IRS through Form 1099-K.

Sorry, no clever landlord tips can help you avoid this fun little form.

Rental Property Tax Deductions You Can Write Off

Rental property expenses add up fast, but many are tax deductible, as long as the IRS considers them “ordinary and necessary.” Pay close attention to the following section, because deductions directly reduce your taxable rental income and improve your bottom line.

Typical Rental Property Deductions

Mortgage interest is typically one of the most significant tax deductions landlords can claim. Property taxes, insurance premiums, and even HOA fees (under certain circumstances) are also fully deductible.

Failing to deduct any of the following rental expenses is like leaving money on the table:

• Mortgage interest
• Property taxes
• Insurance
• Repairs and maintenance
• Property management software costs
• Legal and professional fees
• Advertising and leasing expenses
• Supplies, tools, and materials used for the rental

The above list is not exhaustive, so read this article (written by the IRS) for guidance on which expenses landlords can and cannot deduct.

Repairs (Deductible) vs. Capital Improvements (Not Deductible)

Landlords can deduct repairs and maintenance expenses in the year they occurred, but they must depreciate improvements and renovations. If this statement is confusing, look at it this way:

Repairs keep a property in its original condition, whereas improvements and renovations increase its value. You can deduct repairs, but you must depreciate improvements.

Check out our article on capital improvements vs. repairs and maintenance for a more in-depth analysis.

Travel Expenses

Landlords can deduct travel costs, but only if the travel is directly related to managing their property. For instance, if you’re visiting a rental, meeting with contractors, or collecting rent in person (who does that anymore?), you can likely deduct any related expenses to your trip.

To ensure you can back up any and all deductions, keep mileage logs and receipts, and record the purpose of each rental-related business trip you take.

Rental Property Depreciation Rules

Rental property depreciation allows landlords to deduct a portion of a property’s value each year, which spreads the cost of wear and tear across a set number of years. Depreciation qualifies as a non-cash deduction but can reduce taxable income all the same.

How does depreciation work?

The IRS allows you to depreciate the cost of your rental building over 27.5 years using the straight-line method, which spreads the deduction evenly each year based on the building’s value.

Importantly, depreciation begins when an owner places the property in service, not when they purchase it. For example, the moment you list your rental property on the market, its depreciation clock starts ticking, whether occupied or not.

What can landlords depreciate?

Landlords can depreciate a property’s structure, but not the land it sits on.

Separate property assets (like appliances, flooring, fencing, etc.) are also depreciable over shorter periods, which depend on their useful lives.

As we mentioned earlier, landlords can depreciate capital improvements but can’t write them off as annual tax deductions. For accurate depreciation tracking, keep a detailed record of each improvement’s cost, date, and purpose.

Depreciation Recapture Upon the Sale of a Rental Property

When an owner sells a rental property, the IRS requires them to recapture and tax any depreciation they have already claimed (often at a higher rate). Doing so will significantly affect net proceeds and requires careful advance planning.

If you’re in over your head with depreciation, consider reaching out to a CPA who can help estimate your tax liability and build strategies to minimize it. Additionally, you can consider a 1031 exchange, which defers capital gains and recaptures taxes.

Passive Activity Loss Rules

The IRS typically considers rental income passive, even if you’re an active, hands-on landlord who manages the property yourself. Unfortunately, this rule means that you can’t usually offset losses from rental activity with W-2 wages or active income.

Here are a few passive activity loss rules to consider:

$25,000 Exception for Active Owners

If you actively participate in managing your rental and your adjusted gross income is below $100,000, you may deduct up to $25,000 in passive losses.

Typical landlord activities like screening tenants or coordinating repairs count as active participation under IRS rules, meaning you can legally deduct these expenses without worry.

Phaseouts and Limits

The $25,000 passive activity loss deduction phases out between $100,000 and $150,000 of adjusted gross income and disappears entirely for property owners above the threshold.

Unused passive losses aren’t lost forever, though, as property owners can carry them forward indefinitely into future years.

Real Estate Professional Exception

If you spend more than 750 hours per year and more than half of your working hours on real estate activities, the IRS may classify you as a “real estate professional” for tax purposes.

If you qualify as a real estate professional, you can deduct all of your rental losses, but only if you’re also actively involved in managing your rentals. You’ll also need to either participate in each property or group them together as one for tax purposes.

Tax Forms for Rental Property Owners

Landlords must document all rental income and deductions to the federal government by completing and turning in IRS-approved forms. Submitting inaccurate filings or skipping forms altogether is risky and could lead to audits, denied deductions, or fines.

Here are the essential IRS forms landlords should know and use:

• Schedule E (Form 1040): Core form for reporting rental income, expenses, and depreciation
• Form 4562: Used to report depreciation for new assets and improvements
• Form 8582: Used to calculate and limit passive activity losses
• Form 1099-NEC: Landlords who pay contractors $600 or more during the year must send them this form through the IRS
• Form 1040-ES: Required for making estimated tax payments for those who owe more than $1,000 in taxes

Best Practices for Filing Your Taxes

Keep meticulous records of all your rental income, deductions, and depreciations to stay prepared for tax season. We recommend using accounting software designed for rental property owners to streamline this process and keep your books airtight.

Don’t procrastinate. Waiting until April to sort through expense receipts or calculate depreciation is a white-knuckle move. Instead, review your income and expenses as the year wraps up. Acting proactively affords you time to fix errors, maximize deductions, and avoid last-minute stress.

If all else fails, consider consulting with a real estate tax professional who can help you navigate the complexities of passive losses, depreciation recapture, and capital gains. They can also help you spot missed deductions and increase your chances of surviving an IRS audit.

IRS Rules for Short-Term Rentals and Vacation Properties

Short-term rental rules differ significantly from long-term rental rules. If you rent out a property on Airbnb or Vrbo, this next section is for you.

The 14-Day Rule

Landlords who rent a property for 14 days or less and use it personally for more than 14 days don’t need to report the income earned to the IRS. With that in mind, they also can’t deduct any rental-related expenses accrued while earning income from the property.

When does rental use become taxable?

Once a landlord exceeds the 14-day limit, they must report their rental income to the IRS and prorate all expenses based on how long they rented the property vs. how long they stayed in it themselves.

Remember, Services Trigger Business Classification

Landlords who offer services like cleaning or meals may cause the IRS to treat their rental as a business rather than a passive activity. This classification shifts the tax treatment and could trigger self-employment tax, introducing a new layer of deductions and compliance requirements.

Local Lodging Taxes

To complicate things further, cities and states may assess separate taxes on short-term rental owners. As such, landlords who assume that federal IRS compliance means they’re in the clear locally could be in for a rude awakening.

To avoid issues, reference local licensing, hotel tax rules, and permit requirements before listing your property as a short-term rental.

Common Tax Mistakes Landlords Should Avoid

Landlord tax errors are common (and costly). Here are a few common missteps to watch out for:

Underreporting Income

Failing to report certain income to the IRS (like lease termination fees or tenant-paid expenses) is a red flag that could lead to an audit. To avoid underreporting, brush up on laws, maintain meticulous accounting and bookkeeping, and, if in doubt, consult a tax professional.

Claiming Personal Expenses as Business Expenses

Claiming personal expenses — think travel, meals, home expenses, etc. — as deductions is risky unless they’re directly related to a rental property. If you’re a work-from-home landlord, remember that the IRS limits home office deductions, which must meet strict requirements.

Misclassifying Repairs and Improvements

Repairs are deductible immediately, whereas capital improvements must be capitalized and depreciated over time. Mixing up these classifications is a typical audit trigger for the IRS. Thankfully, landlords who understand the key differences between the two can easily avoid this pitfall.

Failing to Depreciate Properties

Some landlords skip the depreciation process and miss out on significant tax savings as a result. Others fail to recapture depreciation properly when they sell their properties. If you missed out on depreciation in the past, you can catch up using IRS Form 3115.

Keeping Poor Financial Records

Without proper documentation, the IRS might dispute your income and deny your deductions. To stay prepared, maintain digital and physical records for every transaction related to your rental, from repair costs to advertising fees to rent payments.

Also, never mix personal and business expenses within the same bank account.

When to Hire a CPA for Your Rental Property

Many landlords can handle basic taxes independently, but as portfolios grow, hiring a real estate CPA looks more and more like a smart move.

You might want to seek professional tax help if you:

• Own multiple properties,
• Operate short-term rentals,
• Plan to sell and need depreciation recapture guidance,
• Want to qualify as a real estate professional,
• Own property through an LLC or partnership,
• Want to carry passive losses into future years,
• Have doubts about estimated quarterly tax payments.

A good real estate tax professional can help you lower your liability while keeping you IRS-compliant. And, though they don’t come cheap, they can also help you build long-term strategies for 1031 exchanges, structure your entities, or maximize QBI deductions.

Use TurboTenant to Handle Your Rental Accounting

Remember, IRS rules for rental property are non-negotiable.

To keep Uncle Sam off your back, you must understand the tax laws that govern your rentals, report all income, track every expense, distinguish between repairs and improvements, depreciate property accurately, and keep your numbers dialed in.

While this may seem overwhelming, rental accounting and bookkeeping software will help you stay organized, compliant, and focused on growing your portfolio.

Sign up for a free TurboTenant account to put your rental accounting on autopilot today.

FAQs: IRS Rules for Rental Property