Renting out a home or property can be a great way to earn extra money, but it also comes with tax responsibilities. The IRS considers rental income taxable, and it is important to understand how it works. This article will cover everything you need to know about rental income, taxes, and ways to reduce your tax burden.
What Is Rental Income?
Rental income is any money you receive from renting out a property. This includes:
- Monthly rent payments from tenants
- Advance rent payments
- Security deposits (if you keep part of it)
- Fees for services like parking or utilities
- Payments from renting out a room in your home
Is Rental Income Considered Earned Income?
No, rental income is not considered “earned income.” Earned income comes from wages, salaries, or self-employment. Rental income is considered “passive income,” which means you earn it without actively working for it.
How Is Rental Income Taxed?
Rental income is taxed as ordinary income. The tax rate depends on your total income and tax bracket. Here’s how it works:
- Add your rental income to your other sources (salary, business income, etc.).
- Deduct allowable expenses, which include mortgage interest, property taxes, repairs, and maintenance.
- Pay tax on the net rental income (total income minus expenses).
What Tax Deductions Can You Claim on Rental Income?
The good news is that you can deduct many expenses related to rental property. These include:
- Mortgage interest
- Property taxes
- Home Insurance
- Repairs and maintenance
- Property management fees
- Advertising costs
- Depreciation (value reduction of the property over time)
- Utilities (if you pay them)
- Legal and accounting fees
These deductions help reduce the amount of taxable income, lowering your tax bill.
Can You Avoid Paying Taxes on Rental Income?
While you cannot completely avoid taxes, you can reduce them by:
- Deducting all allowable expenses
- Using depreciation to lower taxable income
- Writing off travel costs related to property management
- Living in the property for a few years before renting it (this can qualify you for homeowner tax benefits)
- Conducting a 1031 exchange (selling a rental property and buying another to delay taxes)
Does Rental Income Affect Social Security?
No, rental income does not affect Social Security benefits because it is not considered earned. However, if you run a rental business (providing services like housekeeping), the IRS may classify it as self-employment income, which can affect Social Security taxes.
What Is the Tax Rate for Rental Income?
The tax rate depends on your total taxable income. Here’s a general idea:
- If you earn less than $44,725, your federal tax rate is around 12%.
- If you earn between $44,726 and $95,375, your tax rate is around 22%.
- Higher incomes can be taxed up to 37%.
State taxes also apply, and some states offer deductions for rental expenses.
How to Invest in Rental Property in Different States
When investing in rental properties in different states, consider:
- State-specific tax laws
- Property management services
- Travel costs for inspections
- Different rental market trends
Some states have better tax benefits for rental property owners than others.
Is Rental Property Considered a Business?
If you actively manage multiple properties, provide extra services (cleaning, maintenance), or operate through a company, the IRS may consider your rental property a business rather than a passive income. This can impact your tax situation.
If you run a business and want to lease a home under the business name, you may be able to do so, but the lease terms depend on the landlord’s agreement. Some businesses rent homes for employees as part of company benefits.
How to Get a Rental in Another State
If you want to rent a home in another state, follow these steps:
- Research the rental market and prices.
- Find a local real estate agent or property manager.
- Check lease agreements and state-specific rental laws.
- Arrange virtual or in-person property tours.
Conclusion
Rental income can be a great source of money, but it comes with tax responsibilities. Understanding how to report rental income, what deductions to take, and how to lower taxes is key to keeping more of your earnings. Always keep proper records and consult a tax professional if needed.