US Rental Property Tax Basics: Income, Depreciation and Losses

Rental property is one of the most tax-favoured investments in the United States, and also one of the most commonly mis-reported. Rental income is reported on Schedule E, where gross rents are reduced by operating expenses and by depreciation, a deduction that often converts a cash-positive property into a paper loss.

Deductible operating expenses include mortgage interest, property taxes, insurance, property management fees, repairs and maintenance, utilities you pay, advertising for tenants, legal and accounting fees, HOA dues, and travel to the property for genuine management purposes. The critical distinction is between a repair and an improvement. Fixing a leaking tap is a repair, deductible in full this year. Replacing the roof or remodelling a kitchen is an improvement, added to basis and depreciated over years.

Depreciation is the landlord's structural advantage. Residential rental buildings are depreciated over 27.5 years and commercial over 39, using the building value only — land is never depreciated, so the purchase price must be allocated between the two, typically using the county assessor's ratio. Appliances, carpets and other personal property have shorter lives. Cost segregation studies can accelerate deductions on larger properties by identifying components with shorter recovery periods.

Depreciation is not optional, and that matters on sale. Whether or not you claimed it, the IRS treats the property as depreciated and recaptures it at up to 25 per cent when you sell. Landlords who never claimed depreciation therefore pay the recapture anyway, losing the deduction and keeping the tax. If that describes past years, a change of accounting method can often recover the missed deductions without amending every return.

Losses are restricted. Rental activity is generally passive, so losses can normally only offset passive income rather than salary. Two important exceptions exist. Active participants with adjusted gross income below $100,000 may deduct up to $25,000 of rental losses against other income, phasing out entirely by $150,000. Separately, those who qualify as real estate professionals — meeting demanding hour tests for time spent in real property trades — may treat the activity as non-passive and deduct losses without that cap. Suspended losses are not lost; they carry forward and release on sale.

Short-term rentals sit on a different footing. If the average stay is seven days or fewer, the activity may fall outside the standard rental rules and be treated as a business, which changes both the loss rules and the potential exposure to self-employment tax where substantial services are provided. State and local lodging taxes and registration requirements add a compliance layer that platforms do not handle for you.

Mixing personal and rental use requires allocation. Renting a vacation home for part of the year means splitting expenses by days of rental use versus personal use, and a special rule exempts income entirely when a residence is rented for fewer than fifteen days in the year. Renting to a relative below market rate can convert the property to personal use, disallowing losses.

Two planning tools are worth knowing. A 1031 exchange defers gain by rolling proceeds into another investment property under strict identification and closing deadlines, and is now limited to real property. Converting a rental back to a main home for two of the five years before sale allows partial use of the home sale exclusion, though depreciation recapture still applies. In all cases the deciding factor in an audit is documentation: closing statements, an allocation between land and building, a fixed asset schedule, leases, and a clear record of which expenditures were repairs and which were improvements.