If you receive rental income for the use of a dwelling unit, such as a house or an apartment, you may deduct certain expenses. These expenses, which may include mortgage interest, real estate taxes, casualty losses, maintenance, utilities, insurance, and depreciation, will reduce the amount of rental income that is subject to tax. If you are renting to make a profit and do not use the dwelling unit as a personal residence, then your deductible rental expenses may be more than your gross rental income. Your rental losses, however, generally will be limited by the “at-risk” rules and/or the passive activity loss rules.
If you rent a dwelling unit to others that you also use as a personal residence, limitations may apply to the rental expenses you can deduct. You are considered to use a dwelling unit as a personal residence if you use it for personal purposes during the tax year for more than the greater of:
14 days, or
10% of the total days you rent it to others at a fair rental price.
It is possible that you will use more than one dwelling unit as a personal residence during the year. For example, if you live in your main home for 11 months, your home is a dwelling unit used as a personal residence. If you live in your vacation home for the other 30 days of the year, your vacation home is also a dwelling unit used as a personal residence unless you rent your vacation home to others at a fair rental value for 300 or more days during the year.
A day of personal use of a dwelling unit is any day that it is used by:
You or any other person who has an interest in it, unless you rent your interest to another owner as his or her main home under a shared equity financing agreement
A member of your family or of a family of any other person who has an interest in it, unless the family member uses it as his or her main home and pays a fair rental price
Anyone under an agreement that lets you use some other dwelling unit
Anyone at less than fair rental price
If you use the dwelling unit for both rental and personal purposes, you generally must divide your total expenses between the rental use and the personal use based on the number of days used for each purpose. You will not be able to deduct your rental expense in excess of the gross rental income limitation (your gross rental income less the rental portion of mortgage interest, real estate taxes, and casualty losses, and rental expenses like realtors’ fees and advertising costs). However, you may be able to carry forward some of these rental expenses to the next year, subject to the gross rental income limitation for that year.
There is a special rule if you use a dwelling unit as a personal residence and rent it for fewer than 15 days. In this case, do not report any of the rental income and do not deduct any expenses as rental expenses.
Another special rule applies if you rent part of your home to your employer and provide services for your employer in that rented space. In this case, report the rental income. You can deduct mortgage interest, qualified mortgage insurance premiums, real estate taxes, and personal casualty losses for the rented part, subject to any limitations, but do not deduct any business expenses.
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.
Generally, losses from passive activities that exceed the income from passive activities are disallowed for the current year. You can carry forward disallowed passive losses to the next taxable year. A similar rule applies to credits from passive activities.
Material and Active Participation
Passive activities include trade or business activities in which you do not materially participate. You materially participate in an activity if you are involved in the operation of the activity on a regular, continuous, and substantial basis. In general, rental activities, including rental real estate activities, are also passive activities even if you do materially participate. However, rental real estate activities in which you materially participate are not passive activities if you qualify as a real estate professional. Additionally, there is a limited exception for rental real estate activities in which you actively participate. The rules for active participation are different from those for material participation.
Disposition of Entire Interest
Generally, you may deduct in full any previously disallowed passive activity loss in the year you dispose of your entire interest in the activity.
In contrast, you may not claim unused passive activity credits upon disposition of your entire interest in the activity. However, you may elect to increase the basis of the credit property in an amount equal to the portion of the unused credit that previously reduced the basis of the credit property.