Investment

Real Estate Rental Income and Expenses

This post is part of our series on Taxes Related to Real Estate

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.

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.

Rental Expenses

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.

Personal Use

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.

Limitations

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).

Understanding Capital Gains and Losses

Capital Asset Capital Gains Capital Losses Investment Taxes United States

This post is part of our series on Taxes Related to Real Estate

Almost everything you own and use for personal or investment purposes is a capital asset. Examples include a home, personal-use items like household furnishings, and stocks or bonds held as investments. When you sell a capital asset, the difference between the adjusted basis in the asset and the amount you realized from the sale is a capital gain or a capital loss. You have a capital gain if you sell the asset for more than your adjusted basis. You have a capital loss if you sell the asset for less than your adjusted basis. Losses from the sale of personal-use property, such as your home or car, are not tax deductible.

Capital gains and losses are classified as long-term or short-term. If you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term. To determine how long you held the asset, count from the day after the day you acquired the asset up to and including the day you disposed of the asset.

If you have a net capital gain, a lower tax rate may apply to the gain than the tax rate that applies to your ordinary income. The term “net capital gain” means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss for the year. The term “net long-term capital gain” means long-term capital gains reduced by long-term capital losses including any unused long-term capital loss carried over from previous years. The tax rate on most net capital gain is no higher than 15% for most taxpayers. Some or all net capital gain may be taxed at 0% if you are in the 10% or 15% ordinary income tax brackets. However, a 20% tax rate on net capital gain applies to the extent that a taxpayer’s taxable income exceeds the thresholds set for the 39.6% ordinary tax rate ($413,200 for single; $464,850 for married filing jointly or qualifying widow(er); $439,000 for head of household, and $232,425 for married filing separately).

There are a few other exceptions where capital gains may be taxed at rates greater than 15%:

The taxable part of a gain from selling section 1202 qualified small business stock is taxed at a maximum 28% rate.
Net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28% rate.
The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate.

Note: Net short-term capital gains are subject to taxation as ordinary income at graduated tax rates.

Taxpayers with significant investment income may be subject to the Net Investment Income Tax (NIIT). For additional information on the NIIT, see What is Net Investment Income Tax (NIIT).