Real Estate Tax Calc
The short answer: ordinary income taxed at your marginal rate
Gross rental income — all rent payments you receive, plus any tenant payments for your expenses and any cancelled security deposits — is ordinary income. It is taxed at your marginal federal income tax rate (10% through 37% for 2024 and 2025) and most states' ordinary income rates. It is not capital gain. It is not subject to self-employment tax (15.3%). It is reported on Schedule E, Part I of your Form 1040.
But the amount that actually gets taxed is not your gross rent. You deduct expenses against the rent to arrive at net rental income — the figure that flows to your Form 1040. With good deductions (especially depreciation), many properties produce little or no taxable net income even when they are cash-flow positive.
What counts as rental income
You must report rent when you receive it (cash-basis accounting), regardless of the period it covers. Prepaid rent received in 2024 for 2025 is taxable in 2024. A security deposit you intend to return is not income when you receive it, but if you apply it to unpaid rent or damage, it becomes income at that point. If you receive services or property instead of money as rent (for example, a tenant repairs plumbing in lieu of one month's rent), the fair market value is rental income.
If you cancel a debt the tenant owes (writing off unpaid back rent), that can also be income depending on the circumstances. When you improve the property with tenant improvements that benefit you and are not required under the lease, those improvements are generally not income to you. But a tenant who builds improvements on your property that you will own at lease end with no obligation on your part may create income to you — the rules are technical and depend on the structure of the arrangement.
Deductible expenses that reduce your rental income
Against gross rental income, you can deduct ordinary and necessary expenses paid or incurred in the rental activity. The main categories are: mortgage interest on the rental property; property taxes; insurance premiums; property management fees; advertising and listing fees; repairs and maintenance (but not capital improvements, which must be capitalized and depreciated); professional fees (CPA, attorney for rental matters); supplies; utilities you pay; travel to manage or inspect the property; and depreciation.
Depreciation is typically the largest deduction and the only non-cash one. Residential rental buildings are depreciated over 27.5 years under MACRS; commercial buildings over 39 years. On a $250,000 building (excluding land), depreciation is roughly $9,100 per year for residential property — a deduction that reduces your taxable income without reducing your cash flow. This is the engine behind the tax-efficiency of real estate investing.
Passive activity rules: when losses are limited
The IRS treats rental activities as passive by default under IRC Section 469. Passive losses can only offset passive income — not wages, not self-employment income, not investment income. If your rental deductions (including depreciation) exceed your rental income, creating a rental loss, that loss is generally suspended and carried forward to future years, where it can offset passive income or be released when you sell the property.
Two exceptions allow current deductions. The $25,000 active participation allowance: if you actively participate in managing your rental (making management decisions, approving tenants, setting rents) and your MAGI is under $100,000, you can deduct up to $25,000 of rental losses against ordinary income. The allowance phases out dollar-for-dollar as MAGI goes from $100,000 to $150,000 and is gone entirely above $150,000. Real estate professional (REPS) status: if you spend more than 750 hours annually in real property trades or businesses and those hours exceed 50% of your total working time, your rental activities are non-passive and losses are fully deductible.
How depreciation creates phantom losses
Many rental properties are cash-flow positive — rent exceeds the mortgage payment and other cash expenses — yet show a tax loss. The reason is depreciation, a non-cash deduction that does not correspond to any money leaving your account. If your rental generates $18,000 of annual rent, you pay $10,000 in mortgage interest, taxes, and insurance (cash expenses), and you claim $9,000 of depreciation (non-cash), your net rental income for tax purposes is -$1,000 — a loss — despite positive cash flow.
This phantom loss is suspended (if your income is above $150,000 MAGI) or deductible (if below $100,000 MAGI under the $25,000 allowance). Over years of ownership, suspended passive losses accumulate. When you sell the property, all suspended losses are released and can offset the gain from the sale — a powerful timing benefit.
The 3.8% Net Investment Income Tax
High-income landlords owe an additional 3.8% Net Investment Income Tax on net rental income (and other investment income) if their modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). The NIIT is assessed on the lesser of net investment income or MAGI in excess of the threshold. For a landlord with $50,000 of net rental income and MAGI of $300,000, the NIIT on the rental income is $1,900 (3.8% × $50,000), stacking on top of the regular income tax.
Non-passive rental income — from landlords who qualify as real estate professionals or from short-term rentals where the owner materially participates as a trader — may escape the NIIT, since non-passive rental income is generally not 'net investment income' within the meaning of the NIIT regulations.
What happens when you sell a rental
When you sell a rental property held more than one year, the tax treatment shifts. The gain is split into two parts. The portion equal to the depreciation you claimed (or could have claimed) is unrecaptured Section 1250 gain, taxed at a maximum of 25% federally. The remaining appreciation above your original cost is long-term capital gain at 0%, 15%, or 20%. Both rates are generally lower than the ordinary income rates you paid on rental income while holding.
Any suspended passive losses that accumulated from prior years are released when you sell in a fully taxable disposition. They can offset the gain on the sale, reducing the tax bill. The more passive losses you accumulated, the more they shelter the sale gain — another reason to track them carefully each year even when they do not currently benefit you.
State taxes on rental income
Every state with a personal income tax taxes rental income as ordinary income. State rates range from under 3% to over 13% (California). Most states closely follow federal rules for deductions, but depreciation conformity varies — some states do not allow federal bonus depreciation, requiring a separate state depreciation schedule. A handful of states (Florida, Texas, Nevada, and a few others) have no personal income tax, so rental income in those states bears no state tax.
If you own rental property in a state different from where you live, you may need to file a non-resident return in the property's state, paying that state's tax on the rental income, and claim a credit on your home-state return to avoid double taxation.
A worked example: from gross rent to tax owed
Suppose you collect $30,000 in annual rent on a single-family rental. Your cash expenses are $9,000 of mortgage interest, $4,000 of property tax, $1,500 of insurance, $2,000 of repairs, and $1,800 of management fees — $18,300 total. You also claim $8,000 of depreciation. Your net rental income is $30,000 − $18,300 − $8,000 = $3,700. That $3,700 flows to your Form 1040 and is taxed at your marginal rate — about $814 of federal tax in the 22% bracket.
Notice that the property produced roughly $11,700 of positive cash flow ($30,000 rent minus $18,300 cash expenses) but only $3,700 of taxable income, because the $8,000 depreciation deduction is non-cash. If the activity qualifies, a QBI deduction of 20% of the $3,700 would reduce the taxable amount to about $2,960. This gap between cash flow and taxable income is the central reason rental real estate is tax-efficient.
The QBI deduction on rental income
Since 2018, net rental income that rises to the level of a trade or business may qualify for the Section 199A qualified business income deduction — up to 20% of net rental profit. The IRS created a safe harbor in Rev. Proc. 2019-38: a rental enterprise qualifies if at least 250 hours of rental services are performed annually and the owner keeps separate books and contemporaneous time records. Even outside the safe harbor, many active rentals qualify as a Section 162 trade or business.
The deduction is claimed on Form 8995 (or Form 8995-A for higher incomes) and directly reduces taxable income. For a landlord with $10,000 of net rental profit, the QBI deduction can be worth up to $2,000 of reduced taxable income, lowering the federal tax by several hundred dollars. It is one of the most commonly missed deductions among self-preparing landlords.
Short-term rentals are taxed under different rules
A property rented on average for 7 days or fewer per guest is not a 'rental activity' under the passive-activity rules — it is treated as a trade or business. If you materially participate (for example, by handling bookings, cleaning, and guest services yourself for 100+ hours and more than anyone else), the income and losses are non-passive, and losses can offset your wages and other ordinary income without needing real estate professional status. This 'short-term rental loophole' is popular but heavily scrutinized.
A short-term rental that provides substantial services (daily cleaning, meals, concierge — hotel-like services) can be reclassified as a Schedule C business subject to self-employment tax. Most standard short-term rentals without hotel-like services stay on Schedule E and avoid SE tax, but the distinction matters and depends on the level of services you provide.
Common mistakes that raise your rental tax bill
The costliest mistake is not claiming depreciation. It is not optional in effect: the IRS recaptures depreciation 'allowed or allowable' at sale whether or not you took it, so skipping it forfeits the deduction while keeping the tax. A second mistake is improperly allocating the purchase price between land and building — putting too much toward land shrinks your depreciation, while too much toward the building invites challenge. Use the county assessor's ratio or an appraisal.
Other frequent errors: capitalizing what should be a currently deductible repair (or vice versa), missing the QBI deduction, forgetting to track suspended passive losses on Form 8582, and failing to file a non-resident return for out-of-state property. Each of these either overstates current tax or forfeits a benefit you are entitled to.
Frequently asked questions
Is rental income taxed differently from wages?
Both are ordinary income taxed at the same marginal rates, but rental income is not subject to Social Security and Medicare (self-employment) taxes. It is also passive by default, meaning losses are limited unless you qualify for exceptions.
How does depreciation affect my rental tax bill?
Depreciation reduces your net taxable rental income without reducing cash flow. It often converts a cash-flow-positive rental into a paper loss for tax purposes, deferring taxes until you sell.
What is the $25,000 rental loss allowance?
Taxpayers who actively participate in rental management and have MAGI below $100,000 can deduct up to $25,000 of rental losses against ordinary income. The allowance phases out between $100,000 and $150,000 MAGI.
Do I owe self-employment tax on rental income?
No. Rental income is explicitly excluded from self-employment earnings under IRC Section 1402, so you do not owe the 15.3% SE tax on it.
What tax form reports rental income?
Schedule E (Supplemental Income and Loss), attached to Form 1040. The net income or loss from each rental property is computed on Schedule E and flows to your 1040.
Can I take the 20% QBI deduction on rental income?
Often yes. If your rental rises to the level of a trade or business — or meets the 250-hour safe harbor in Rev. Proc. 2019-38 — up to 20% of net rental profit is deductible under Section 199A on Form 8995 or 8995-A.
Are short-term rentals taxed differently from long-term rentals?
Yes. Rentals averaging 7 days or fewer per guest are treated as a trade or business, not a passive rental activity. With material participation, losses can offset ordinary income without real estate professional status, and substantial hotel-like services can move the income to Schedule C with self-employment tax.
How much of my rent is actually taxed?
Only the net — gross rent minus deductible expenses including depreciation. Because depreciation is a large non-cash deduction, many cash-flow-positive rentals show little or no taxable income, and some show a paper loss.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.