Owning a rental property can be a great source of passive income, but just like any other investment, your rental income must be reported on your annual tax return. With tax season seemingly always approaching, this brings about questions for many first-time real estate investors and even seasoned investors:
“How is rental income taxed?”
“What are the rental income tax rates?”
“Will my rental income be taxed any differently this year?”
“What are some investment property tax deductions?”
“How can I avoid an IRS audit?”
In this article, we will examine the rental income tax rate so that you can be confident that you are:
If you’re ready to learn everything you need to know about the rental income tax rate and investment property tax deductions, let’s get started!
What Is The Rental Income Tax Rate?
You’re probably asking yourself as you fill out your taxes: what is the rental income tax rate?
To put it simply, rental income is taxed the same as ordinary income.
Rental Income Tax Rates for 2020
To calculate your rental income tax rate, simply add your rental income for the year to any other sources of income.
Using the sum of those two amounts, you can then find your tax rate based on the marginal tax rates the IRS provides.
As defined by the IRS for the year 2020, the marginal tax rates for the top tax rate maxes out at 37% for individual taxpayers with incomes greater than $518,400 or married couples filing jointly with incomes greater than $622,050.
Next, we’ll look at the tax rates to help you determine your rental income tax rate.
- 35% for individuals making greater than $207,350 but less than $518,400 or couples filing jointly who made more than $414,700 but less than $622,050.
- 32% for individuals making greater than $163,300 but less than $207,350 or couples filing jointly who made more than $326,600 but less than $414,700.
- 24% for individuals making greater than $85,525 but less than $163,300 or couples filing jointly who made more than $171,050 but less than $326,600.
- 22% for individuals making greater than $40,125 but less than $85,525 or couples filing jointly who made more than $80,250 but less than $171,050.
- 12% for individuals making greater than $9,875 but less than $40,125 or couples filing jointly who made more than $19,750 but less than $80,250.
The lowest rate is 10% for individuals making less than $9,875 or couples filing jointly making less than $19,750 per year.
Next, we’ll look at:
- how you can determine your rental income
- what you should include in your rental income
- what you should exclude from your rental income
Types of Rental Income
It’s critical to keep track of all income and expenses incurred at the rental property throughout the year in order to calculate your rental income — as well as investment property tax deductions.
Because rental income is considered by the IRS as any payment you receive from anyone who uses or occupies a property, you must report all rental income received for a property.
This includes both rent for that year and any advance rent you might receive even if it is for a different year.
The following are common types of rental income that you need to consider when discussing the rental income tax rate.
The IRS considers advance rent as “any amount you receive before the period that it covers.”
This should be included as income on your taxes.
Canceling a Lease
If your tenant pays you to cancel a lease, the IRS considers the amount you receive as rent.
Be sure to include the payment in your rental income in the year you receive the amount.
Expenses Paid by Tenant
If your tenant pays any of your expenses, the IRS considers those payments as rental income — something important to think about with rental income tax rate.
Keep in mind that since you must include this amount in income, you can also deduct the expenses if they are deductible rental expenses, such as:
- Auto and travel expenses
- Cleaning and maintenance
- Interest (other)
- Legal and other professional fees
- Local transportation expenses
- Management fees
- Mortgage interest paid to banks, etc.
- Rental payments
Property or Services
In the event that you receive property or services as rental income instead of money from your tenant, you must include this in your taxable rental income — according to the IRS, you must include the “fair market value of the property or services.”
If the services are provided at an agreed upon or specified price, the IRS considered that price as the “fair market value.”
If you plan on returning a security deposit to your tenant, don’t include it as income.
But if you keep a portion or all of it, you must include the amount you keep in your income in that year.
In the event that the security deposit will be used as a final payment of rent, it is considered “advance rent” and must be included in income.
When you add these items up, you might be surprised to see this pushed you up a few tax brackets.
In the next section, we will cover deductions that can reduce your rental income tax rate and help you save you money.
Investment Property Tax Deductions
There are several investment property tax deductions to consider.
When calculating investment property tax deductions, one major deduction you can take is the cost of depreciation for the property.
Straight Line Depreciation
The easiest and most common way of depreciating a property is called Straight-Line Depreciation.
When using this investment property tax deduction, you must first know the cost basis, which is generally your acquisition cost of the property plus any expenses, including any money you borrowed to buy the property.
The cost basis is then spread over the tax life of your property, generally defined as 27.5 years.
If this is your first year owning the property, this investment property tax deduction will be prorated over the number of months, with the first month only being counted as half.
Rental Income Tax Rate Example
Let’s look at a rental income tax rate and investment property tax deduction example.
Let’s say you bought a property in September of last year for $250,000.
The cost basis calculated would be $250,000 divided by 27.5 years equaling out to a depreciating expense of $9,090 per year.
For your taxes this year, you would take $9,090 and multiply it by .29 (3.5 months/12 months) giving you a depreciation expense of $2,651 for the first year.
Any other costs related to the property can be used as an investment property tax deduction, including:
- maintaining the property
- any interest paid on the property's mortgage
- advertising costs
- HOA or condo fees
- local property taxes
When taking any investment property tax deductions to reduce your rental income tax rate, be sure all expenses are ordinary and necessary.
How to Report Rental Income to the IRS
After taking all necessary deductions from your rental income and you have calculated your rental income tax rate, you must report all income and deductions on Schedule E.
The total income calculated from your rental property listed on your Schedule E form then carries onto your Form 1040.
The Bottom Line: Rental Income Tax Rate
As a real estate investor, the key for paying rental income tax is knowing how your rental income tax rate is calculated, and knowing the investment property tax deductions you can take to avoid overpaying — and save money on your taxes each year.
Here are a few more additional tax resources to help you pay less taxes legally:
- Here are 4 proven ways to pay less taxes
- Discover how homeowners save big on taxes
- Find out everything you need to know about the inheritance tax
- Learn how to fill out IRS Form 4797 for your real estate business line by line here
- Not sure where to begin the process of filing taxes? Here’s a beginner’s guide