This post is part of our series on Taxes Related to Real Estate
- Income Losses and Credits from Passive Activities Explained
- Understanding Capital Gains and Losses
- General ITIN (Individual Taxpayer Identification Number) Information
- What is Net Investment Income Tax (NIIT)?
- What is FIRPTA Withholding?
- Taxes When Renting Residential and Vacation Property
Cash or the fair market value of property or services you receive for the use of real estate or personal property is taxable to you as rental income. In general, you can deduct expenses of renting property from your rental income.
Most individuals operate on a cash basis, which means they count their rental income as income when it is actually or constructively received, and deduct their expenses when they are paid. Rental income includes:
- Amounts paid to cancel a lease – If a tenant pays you to cancel a lease, this money is also rental income and is reported in the year you receive it.
- Advance rent – Generally, you include any advance rent paid in income in the year you receive it regardless of the period covered or the method of accounting you use.
- Expenses paid by a tenant – If your tenant pays any of your expenses, those payments are rental income. You may also deduct the expenses if they are considered deductible expenses.
- Security deposits – Do not include a security deposit in your income if you may be required to return it to the tenant at the end of the lease. If you keep part or all of the security deposit because the tenant breaks the lease by vacating the property early, include the amount you keep in your income in that year. If you keep part or all of the security deposit because the tenant damaged the property and you must make repairs, include the amount you keep in that year if your practice is to deduct the cost of repairs as expenses. To the extent the security deposit reimburses those expenses, do not include the amount in income if your practice is not to deduct the cost of repairs as expenses. If a security deposit amount is to be used as the tenant’s final month’s rent, it is advance rent that you include as income when you receive it, rather than when you apply it to the last month’s rent.
Examples of expenses that you may deduct from your total rental income include:
- Depreciation – Allowances for exhaustion, wear and tear (including obsolescence) of property. You begin to depreciate your rental property when you place it in service. You can recover some or all of your original acquisition cost and the cost of improvements beginning in the year your rental property is first placed in service, and beginning in any year you make improvements or add furnishings.
- Repair Costs – Expenditures made to keep your property in good working condition but do not add to the value of the property.
- Operating Expenses – Other expenditures necessary for the operation of the rental property, such as the salaries of employees or fees charged by independent contractors (groundkeepers, bookkeepers, accountants, attorneys, etc.) for services provided.
If you are a cash basis taxpayer, you cannot deduct uncollected rents as an expense because you have not included those rents in income. Repair costs, such as materials, are usually deductible.
There are special rules relating to the rental of real property that you also use as your main home or your vacation home. For information on income from these rentals, or from renting at an amount less than the fair market value, refer to Taxes When Renting Residential and Vacation Property.
If you do not use the rental property as a home and you are renting to make a profit, your deductible rental expenses can be more than your gross rental income, subject to certain limits. For information on these limitations, refer to Income Losses and Credits from Passive Activities Explained.
Net Investment Income Tax
If you have a rental profit, you may be subject to the Net Investment Income Tax (NIIT). For more information, refer to What is Net Investment Income Tax (NIIT).