Is Rental Income Taxed as Ordinary Income?

The short answer to whether rental income is taxed at the level of ordinary income (as opposed to the lower capital gains level) is yes, but...

Yes, rental income is taxed as ordinary income, but some deductions available to landlords can reduce the amount of rental income that is taxed. Some of these deductions are available to any rental property owner, and some are restricted to those who rent property as a business. Let’s start with the basics:

The IRS defines rental property as a dwelling like a single-family home, mobile home, or condominium. To qualify as a rental, the property must not be used by the owner for either 14 days of the year or 10 percent of the days the home is rented for fair market value. Here’s what that looks like:

If you rent the home out at market value for 200 days a year, you can use it personally for 20 days. If you rent the home to others for 300 days in a year, you can personally use it for 30 days. However, if you rent the home to others for fewer than 140 days, you may only use it personally for 14 days. Personal use exceeding these limits will disqualify the dwelling from being considered a rental.

Rental property ownership allows deductions from income.

The rent you receive is income. Other income sources include any service a tenant provides in exchange for rent or rent reduction. For example, if the tenant cares for the landscaping or performs minor repairs in return for a reduced rent payment, the value of those services counts as rental income. Also, if you withhold refunding any of a tenant’s security deposit, that amount of money is rental income.

Still, there are ample deductions available to reduce the income:

• Mortgage interest (not subject to the same limits as apply to your personal residence)
• Property taxes (not subject to the State and Local Tax (SALT) limits included in the Tax Cuts and Jobs Act)
• Property management and advertising costs
• Insurance
• HOA fees
• Utilities if you pay them
• Maintenance
• Depreciation (on a 27.5-year schedule, only for the part of the property you rent out, not including land value)

If you use the home personally, you must reduce the deductions proportionally. So, if you occupy the property 10 percent of the time, reduce the deductions by ten percent.

Does my rental business qualify for the TCJA pass-through deduction?

The Tax Cuts and Jobs Act, passed in 2017, created a temporary 20 percent deduction in income for owners of pass-through businesses. The deduction became effective in 2018 and extends through the 2025 tax year. For landlords, eligibility for this substantial deduction relies on whether the rental activity is a business or an investment. According to NOLO.com, property owners must work regularly and continuously at their business to be considered a business for tax purposes. To simplify the determination for small businesses, the IRS created a safe harbor for landlords to demonstrate that their work is a business rather than an investment. They meet the safe harbor requirements by showing these particulars:

1. Spending at least 250 hours on residential real estate services each year
2. Maintaining separate records of income and expenses for each rental property.
3. Maintaining records of rental services performed.

By properly and thoroughly maintaining documentation of expenses related to your rental properties, you may be able to reduce the amount of income that you pay taxes on.