Owning rental property can be a great way to build wealth — but when tax season rolls around, things can get complicated fast. Here’s a simplified breakdown of the most important tax rules you need to know if you own residential rental property.
💰 Reporting Rental Income
The IRS considers almost anything you receive from a tenant as income: – Rent payments – Early lease cancellations – Security deposits used for rent or damages – Tenant-paid expenses – Services received instead of rent (like repairs)
If you rent a property fewer than 15 days per year, you don’t have to report the income — but you also can’t deduct any expenses. This is known as the Masters exception (named for high-demand event rentals).
📊 What You Can Deduct
You can lower your taxable rental income by deducting expenses related to the upkeep and management of your property. Common deductions include: – Mortgage interest – Property taxes – Insurance – Advertising – Utilities – Repairs (but not improvements)
Note: You can’t deduct the principal portion of your mortgage payments. That’s considered a reduction in your loan balance, not an expense.
📈 Passive Activity Loss Rules
In most cases, rental activity is considered a passive activity — and if you report a loss, that loss can only offset other passive income.
However, if you’re actively involved in managing your rentals, you may qualify for material participation status, which could allow you to deduct losses against your regular income.
The most common test: You worked 500+ hours on the rental during the year.
🏢 Selling Your Rental Property
When you sell a rental: – Gain = capital gain (taxed at lower rates) – Loss = ordinary loss (can offset regular income)
Make sure you keep records of any improvements, as they increase your property’s basis — and could reduce your taxable gain.
♻️ 1031 Exchanges
Want to sell a property but avoid paying taxes right away? You may qualify for a 1031 exchange, which lets you defer capital gains tax by reinvesting in a similar property.
Important rules: – Identify new property within 45 days – Close on it within 180 days – Use a qualified intermediary to hold the money
Remember: Taxes are deferred, not eliminated. You’ll pay when you eventually sell without doing another 1031 exchange.
🤝 Net Investment Income Tax (NIIT)
High earners may owe an extra 3.8% tax on rental income or capital gains if their Modified Adjusted Gross Income (MAGI) exceeds: – $200,000 (single) – $250,000 (married filing jointly)
Example: If your MAGI is $250,000 and you sell a property for a $300,000 gain, you’d only owe NIIT on the $50,000 above the threshold. That’s $1,900 in extra tax.
Got Questions?
If you’re a landlord or real estate investor, we’re here to help you make the most of your tax strategy.
📞 Contact LP Tax & Bookkeeping Pros in Greenville, TX
Ralph Pinney | 303-881-9762