Renting Out a House: Income, Deductions, and Depreciation

Renting out a house has real tax implications: the rent you collect is taxable income, you report it on Schedule E of your Form 1040, and you get to subtract operating costs and depreciation before you’re taxed on what’s left.¹ The catch is that the tax code limits when rental losses can shelter your other income, and it eventually claws back some of your depreciation when you sell. Understanding both sides of that trade is what separates a landlord who plans well from one who gets surprised at closing.

What the IRS Counts as Rental Income

Rental income is broader than the monthly rent check. The IRS defines it as any payment you receive for the use or occupation of your property.² A few categories trip up new landlords:

Advance rent. If a tenant pays first and last month upfront, the full amount is income in the year you receive it, even though the last month covers a future period.³
Lease cancellation fees. Money a tenant pays to break a lease early is rental income in the year you receive it.³
Tenant-paid expenses. If a tenant pays your water bill or property tax directly, those payments count as extra income to you. The offset is that you can deduct the same expenses.³
Services instead of rent. A tenant who paints your rental in exchange for $1,200 in rent hasn’t spared you a tax bill. You report the fair market value of the work as income.

Security deposits sit outside this rule when you intend to return them. A refundable deposit is not income when received. It becomes taxable in the year you keep any portion because the tenant broke the lease or caused damage. Label something a “security deposit” but actually apply it as the final month’s rent, and the IRS treats it as advance rent, taxable right away.⁴

What You Can Deduct

You can deduct the ordinary and necessary costs of managing and maintaining the rental. The IRS specifically names advertising, insurance, mortgage interest, property taxes, management fees, legal fees, utilities, and cleaning among the deductible categories.²

Travel to the property counts too. If you drive to handle maintenance, collect rent, or meet a contractor, you can deduct either your actual vehicle costs or the standard mileage rate. For 2026, the IRS standard mileage rate for business use is 72.5 cents per mile.⁵ If you use the standard rate for a vehicle you own, you must use it in the first year the vehicle is available for business. After that, you can switch between methods annually. A leased vehicle locked into the standard rate must stay with it for the entire lease.

Repairs vs. Improvements

A repair keeps the property in its current working condition: fixing a broken window, patching a leaky pipe, repainting a room. Those costs are fully deductible the year you pay them.

An improvement adds value, extends the property’s useful life, or adapts it to a new use: a new roof, a new furnace, an added deck. You can’t write off an improvement all at once. You capitalize the cost and recover it through depreciation over the property’s remaining recovery period. Getting this wrong is one of the most common audit triggers for landlords. A cost that fixes something broken is usually a repair; a cost that makes something meaningfully better or newer is usually an improvement.

Depreciation Is the Big Deduction

Depreciation is the largest non-cash deduction most landlords claim. It recovers the cost of the building over time even though no additional money leaves your account. The IRS requires the Modified Accelerated Cost Recovery System, which sets residential rental property at a 27.5-year recovery period using the straight-line method.⁶

Land cannot be depreciated because it doesn’t wear out.² You have to separate the value of the building from the value of the land. Buy a property for $275,000 with $55,000 of that attributable to land, and your depreciable basis is $220,000. Dividing by 27.5 gives roughly $8,000 a year in depreciation.

Depreciation starts when the property is ready and available for rent, not when a tenant moves in.² List the property in June and the clock starts in June, even if no one signs a lease until September. A mid-month convention applies, so the first month counts as half a month.

Depreciation isn’t optional. Skip it during your ownership years and the IRS still treats you as if you claimed it when you sell, which is why the recapture rule described below can bite twice.

The Catch: Passive Activity Loss Rules

Rental real estate is generally classified as a passive activity. Losses can offset other passive income but not your salary or wages. If your rental shows a $10,000 loss after depreciation and you have no other passive income, you can’t automatically use that loss to shrink your W-2 income.

An exception matters for most small landlords. If you actively participate in managing the rental, you can deduct up to $25,000 of rental losses against non-passive income each year.⁷ Active participation is a lower bar than it sounds: approving tenants, setting rent, and authorizing repairs count even if a property manager handles day-to-day work. You must own at least 10% of the property.

The $25,000 allowance phases out as income rises. It drops by $1 for every $2 your modified adjusted gross income exceeds $100,000, disappearing entirely at $150,000.⁷ A landlord earning $130,000 can only deduct $10,000 in rental losses against non-passive income that year. Disallowed losses carry forward and can offset future rental income or be fully deducted in the year you sell the property.

A separate carve-out exists for real estate professionals, which requires more than 750 hours a year in real property activities and more than half of all personal services performed across your businesses.⁸ That’s realistic for a full-time property manager, developer, or realtor and effectively out of reach for someone with a W-2 day job.

If You Also Use the House Yourself

Personal use of a rental changes the math. Under Section 280A, the property is treated as your residence if you use it personally for more than 14 days or more than 10% of the days it’s rented at fair market value, whichever is greater.⁹

Cross that line and you must divide expenses between personal and rental use by day count. Rent a home 100 days and use it personally 20, and only five-sixths of the shared expenses can be allocated to the rental. More importantly, rental deductions cannot exceed rental income for the year.⁹ A vacation home you also use can’t generate a tax loss. Excess expenses can carry forward to years when the rental produces enough income to absorb them. Personal use includes days spent by your family or by anyone paying below fair market rent.

The flip side is friendlier. Rent your primary residence or vacation home for fewer than 15 days a year and the income is completely tax-free and doesn’t need to be reported. You also can’t deduct rental expenses for those days.⁹ This is sometimes called the Augusta Rule, and it can be lucrative for properties near major sporting events or festivals.

What Happens When You Sell

Selling triggers two layers of federal tax that landlords often don’t anticipate until closing.

The first is capital gains tax. Your taxable gain is the sale price minus your adjusted basis, which is the original purchase price plus improvements minus all the depreciation you took or should have taken. Years of depreciation steadily lower your basis and inflate your gain.

The second is depreciation recapture. Depreciation you claimed is “recaptured” and taxed at a maximum federal rate of 25%, higher than the long-term capital gains rate most taxpayers pay. Claim $80,000 in depreciation over a decade and you could owe up to $20,000 in recapture, on top of any capital gains tax on the rest of the profit. Recapture applies even if you never actually claimed the deduction, which is why skipping depreciation during your ownership years costs you twice.

A like-kind exchange under Section 1031 lets you defer both capital gains and recapture by reinvesting the proceeds into another investment property. The replacement must be real property held for productive use or investment, and the deadlines are strict:¹⁰

45 days from the sale to identify potential replacement properties in writing.
180 days from the sale (or the due date of your return for that year including extensions, whichever comes first) to close.

Miss either deadline and the whole exchange is disqualified. Most landlords use a qualified intermediary to hold the proceeds during the exchange window, since touching the funds yourself can also blow up the transaction.

Reporting and Paying Along the Way

Rental income and expenses go on Schedule E (Form 1040), Part I.¹ The form asks for the property address, type, and personal-versus-rental day counts. Line 3 captures gross rental income; lines 5 through 19 cover categories like advertising, insurance, repairs, taxes, and depreciation. The net figure flows to your Form 1040.

No one withholds taxes from rent the way an employer withholds from wages. If you expect to owe $1,000 or more after subtracting withholding and credits, the IRS expects quarterly estimated payments. For tax year 2026 the deadlines are April 15, 2026; June 15, 2026; September 15, 2026; and January 15, 2027.¹¹ Underpaying or missing a deadline can trigger a penalty on the shortfall. If your W-2 withholding already covers your total tax bill, separate estimates may not be necessary.

Pay any independent contractor $600 or more during the year for rental work, such as a plumber, handyman, or landscaper, and you generally have to file a Form 1099-NEC. It’s due to the contractor by January 31 of the following year and must be filed with the IRS. Payments to corporations are usually exempt; payments to sole proprietors and partnerships are not. Collecting a W-9 from every contractor before you pay them makes January far easier.

Records matter for longer than you’d think. The IRS generally wants tax records kept for three years, but property records should be held until the statute of limitations expires for the year you dispose of the property.¹² In practice, keep your purchase documents, closing statements, improvement receipts, and depreciation schedules for the whole time you own the house, plus at least three years after you sell. Lose those records and you may not be able to prove your basis at sale, and the IRS won’t give you the benefit of the doubt.

1
Internal Revenue Service. 2025 Instructions for Schedule E (Form 1040)
2
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
3
eCFR. 26 CFR 1.61-8 – Rents and Royalties
4
Internal Revenue Service. Rental Income and Expenses – Real Estate Tax Tips
5
Internal Revenue Service. IRS Sets 2026 Business Standard Mileage Rate at 72.5 Cents per Mile, Up 2.5 Cents
6
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
7
Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
8
Internal Revenue Service. Publication 925
9
Office of the Law Revision Counsel. 26 USC 280A – Disallowance of Certain Expenses in Connection With Business Use of Home, Rental of Vacation Homes, Etc.
10
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
11
Internal Revenue Service. 2026 Form 1040-ES
12
Internal Revenue Service. How Long Should I Keep Records?