The short answer is that rental income is taxed as ordinary income. However, there is more to it. Rental property owners can reduce their tax burden in a number of ways. In most cases, the taxpayer must report all rental income on their tax return.
In general, they use Schedule E (Form 1040) to report income and expenses from rental real estate. Yes, rental income is taxable, but that does not mean that everything you collect from your tenants is taxable. You are allowed to reduce your rental income by subtracting the expenses you incur to prepare your property for rental, and then to maintain it as a rental property. Income from a rental property is taxed as ordinary income, and the property investor pays tax according to his marginal tax bracket.
Rental income is considered passive income for the limitation of passive loss rules. One exception is for qualified real estate professionals. If your rental income exceeds your expenses, you will report the income. However, if your rental income is less than your expenses, you should refer to the special rules.
These rules tell you whether you can set off the loss against other income. Normally, you cannot deduct passive losses from non-passive income, such as wages. You may have several sources of passive income, such as several rental homes. If so, you can deduct the loss from them if the income covers it.
If they do not, the excess loss is carried forward to later years. Rental income generally does not include a security deposit if the taxpayer plans to return it to his tenant at the end of the lease. But if the taxpayer keeps some or all of the security deposit for a year because the tenant fails to comply with the terms of the lease, then the taxpayer includes the amount withheld as rental income in that year. If you accept the offer, include in your rental income the amount the tenant would have paid for two months' rent.
If you cannot, you have to carry the loss forward to another year, offsetting that year's passive income. The schedule has space for three rental properties, but if you need more space you can attach as many E schedules as you need. In addition to the amounts you receive as normal rental payments, there are other amounts that may be rental income and must be declared on your tax return. If you have more than three rental properties, complete and attach as many Schedules E as necessary to list the properties.
In fact, any rental property owner, including you, can own an investment property that generates a solid cash flow each month and, at the same time, report a loss on your tax return. For example, if a tenant pays first and last month's rent at move-in, both payments will be taxable even though the lease does not end until the following year. You can claim special loss relief for rental property activities that fall outside the general rule. As a general rule, rental property is by definition a passive activity and is subject to the passive activity loss rules.
Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. Know the education credits and deductions you are entitled to and claim them on your tax returnStart. Again, in real life appliances and carpet may last much longer, but for tax and depreciation purposes their useful life has come to an end. If the property was gifted to you, or if you inherited it, or if you traded another property for your current one, there are special rules for determining your tax basis in your rental property.
You have probably read about some very wealthy real estate investors who have a lot of free cash flow but pay almost nothing in income taxes.