The IRS treats rental income as ordinary income, but savvy landlords can leverage various deductions like mortgage interest, operating costs, and depreciation to lower their tax bill.  Understanding your tax liability is crucial for effectively managing rental property finances.

How Is Rental Income Taxed When You Have a Mortgage? 

Rental income is taxed as regular income by the IRS. Landlords need to report it and include various payments like nonrefundable deposits and cleaning fees.

Landlords can lower their taxable income with deductions for mortgage interest, property taxes, and other operating expenses. It's important to keep all records of these expenses.

Using your rental property for personal reasons or how long you've owned it can greatly affect your taxes. This includes dealing with capital gains tax and special rules for primary residences used as rentals.

Nearly 10 million Americans recorded rental income on their tax returns in 2020, according to the Internal Revenue Service (IRS). How many properties did those people own? An astonishing 17 million.

Whether you’ve recently joined their ranks or plan to do so sometime in the next tax year, there’s a not-so-minor detail you need to know: how the IRS taxes rental income. 

The short answer is that the IRS taxes rental income like ordinary income even if you have a mortgage. The longer answer is that there are several ways to reduce your taxable income from rentals, as well as a few situations that can impact how you file. 

The IRS taxes rental income as ordinary income regardless of whether you have a mortgage. However, how you file those taxes is a little different. While you report your ordinary income on a W2, rental income is categorized as supplemental income. To report rental income, you must file a tax return using Schedule E on Form 1040. The IRS will then tax your rental income at the same rate as your regular income based on your tax bracket. 

Keep in mind, too, that reporting rental income doesn’t end with the rent checks. The IRS defines rental income as any payment you receive for the use of your property and can include: 

Nonrefundable deposits (e.g. security deposits)

When you pay is also critical. If you expect to earn more than $1,000 in rental income, the IRS will require estimated tax payments. You can either pay quarterly (usually on the 15th of the first month of the quarter) or increase your W2 withholding to account for the rental income you expect to earn. 

Use Smart Rates™ to optimize your pricing strategy.

Calculating rental income is particularly tricky for short-term rental (STR) owners, with fluctuating rates and occupancy and a lack of historical data to draw from. Many hosts calculate income in one of two ways: manually or using a vacation rental calculator.

A simple equation many STR hosts use to manually estimate their Airbnb revenue is multiplying the annual occupancy rate by the average daily rate (ADR) by 365 (for the number of days in a year). 

Using our data from Jackson Hole as an example: if the occupancy rate is 36% and the average daily rate is $409.50, you’ll multiply 409.5 x .36 x 365 for an estimate of $53,808.30 in total annual rental income. However, if your property is not available all year round, then you’ll want to take that into consideration.

2. Estimate Income With a Vacation Rental Calculator

Crunching the numbers on your own won’t always account for unexpected shifts in supply or demand that affect your rental income. An Airbnb calculator can offer extremely accurate revenue estimates by: 

Integrating critical market metrics like seasonality and occupancy 

Comparing your property to similar listings 

It’ll then project the total annual rental income based on the real performance of similar properties. You can use that estimate to calculate rental income tax for any given tax year. AirDNA’s Rentalizer also offers a monthly breakdown to help you dig deeper into the real revenue you can expect to earn.

Tax Deductions You Can Use to Offset Rental Property Income

Deductions can reduce your tax liability, meaning the amount you’ll owe in taxes. Roughly 90% of taxpayers take the standard deduction, but itemizing your deductions can cut back your taxable income even further. 

This can be especially beneficial for STR hosts who incur any number of costs to operate their rentals. The nine tax deductions hosts most often take are: 

Mortgage interest payments: Your mortgage itself isn’t a deductible expense, but mortgage interest payments are.

Property taxes: Deduct any property taxes associated with your rental property.

Operating costs: This includes property management fees, costs for maintenance and repairs, and utilities. 

Travel: If you own multiple STRs and need to travel to them as part of your rental property business, you can deduct the expense of those trips. 

Home Office Expenses: Some STR hosts are hands-off, but if you’re managing your rental business from a dedicated location in your home, you can deduct a portion of your utilities and home insurance. 

Professional Fees: Many hosts work with lawyers, accountants, property managers, and more. The fees you pay for these types of services are usually deductible expenses. 

Advertising: If you pay to market your STR or list it on a site, those fees are also deductible expenses. 

Insurance: You can deduct the insurance premiums you pay for your rental coverage. 

Depreciation: As your property loses value due to wear and tear, you can deduct a fixed percentage of your taxable income to help with improvements. 

All of the above are acceptable tax deductions, but there’s one thing you have to get right before you can: documentation. If you get audited, the IRS will need a paper trail for every item you deduct. Save all receipts and invoices so you can verify your rental expenses if the IRS asks. 

Depreciation happens when a rental loses market value. It can happen if the housing market shifts or simply due to the wear and tear of operating a rental. The good news is the IRS allows a depreciation deduction that you can collect as soon as your property is available to rent. 

You’ll meet the IRS’s criteria for depreciation if: 

The property is income-producing, e.g. an STR

The property will last more than one year

If you check all the above boxes, you can deduct 3.636% of your taxable income for every year you own and operate your rental property. That deduction is the same amount rental properties tend to depreciate each year, and it covers the cost of improving the property. 

Many real estate investors buy residential rental properties because they’d like to stay there themselves. While you don’t have to give up your favorite vacation spot to simplify your taxes, whether you personally use your rental property—and how you use it—can impact your taxes. 

The important thing is to determine whether the IRS will define your property as a rental or as a personal residence. To keep it in the rental category, consider: 

Whether your property is considered a rental or a personal residence depends on how many days you use it yourself. If you use your STR for more than 14 days or more than 10% of the total days you rent it (whichever is greater), the IRS will tax it as a “mixed-use” property, meaning a property that you both rent out and use personally. 

It’s not a bad thing if your property is categorized as mixed-use, but you do need to know how to file. Hosts with mixed-use properties must separate the expenses they incur while operating the property as a rental and those that arise while they use it personally. Come tax time, you can only deduct the portion tied to rental expenses.  

A net loss happens when your rental expenses exceed your rental income. How that impacts your taxes depends on how your property is classified. Personal residences aren’t eligible to deduct the net loss from their other income, but rental properties are. 

Why? A loss on a rental property is considered a passive activity loss, so you can only deduct it from passive income (e.g. rental property income) and not W2 income. 

What if you don’t use your office to manage your rentals, but you do have a dedicated room or suite in your home that you rent out? You may be able to use that space to qualify for the home office deduction because the IRS often considers renting a room as “business use of home.” 

AirDNA’s vacation rental pricing tool uses data-driven recommendations to propose the best daily rates.

Taxes That Apply When You Sell a Rental Property

New real estate investors often think they can sell a property and walk away with a sizable profit without looking back. However, there are several tax considerations when you sell a rental property. How much you’ll owe in taxes depends on how long you’ve owned the property, whether it’s classified as a rental or a personal residence, and how much you earned from the sale. 

This is the most common tax real estate investors face. The capital gain is the difference between the sale price and the adjusted value (usually the home value plus improvements and minus depreciation). 

If you owned the property for less than a year, it’s considered a short-term capital gain, and you’ll pay your normal income tax rate. If you owned the property for more than a year, it’s considered a long-term capital gain and your tax rate will typically be lower.

If you deduct depreciation from your taxable income, you may also have to pay depreciation recapture once you sell. The “recapture” is the amount of depreciation deductions you claimed or could have claimed. It’s typically taxed at 25%.

NIIT is a 3.8% tax that typically applies to people with higher incomes. It applies to certain types of net investment property income (e.g. the net amount you earned from selling your property). Rental property owners that fall in this bracket typically pay an additional 3.8% tax on capital gains. 

Also called a tax-deferred exchange, this is a strategy to defer paying taxes. If you use the proceeds from your investment property to purchase another property within a certain period after the sale, you may be able to defer claiming your capital gains and therefore avoid paying both capital gains tax and depreciation recapture. 

The tax rules are a little different if you’ve been operating your primary residence as a short-term rental. As long as the property was your primary residence for two of the last five years, you may be eligible for a capital gains exclusion, meaning the proceeds aren’t considered a capital gain and you don’t have to pay that tax on them. 

Short-term rental investing has a lot of silver linings, but there’s also plenty of red tape. While the above offers an overview of how rental property income is taxed, it’s also important to consult with a tax professional or accountant. Taxation can vary slightly from state to state, and you may be eligible for different deductions or exclusions based on your unique situation. 

Understanding your tax liability before you invest is critical, but so is how much revenue you can expect to earn. Estimate the revenue potential for any property, anywhere, so you can be sure the tax liability is worth it—both when you buy, while you operate, and if and when it’s time to sell. Learn more about investor tools from AirDNA. 

How Is Rental Income Taxed When You Have a Mortgage? | AirDNA

How Is Rental Income Taxed When You Have a Mortgage?

Key Takeaways
Rental income is taxed as regular income by the IRS. Landlords need to report it and include various payments like nonrefundable deposits and cleaning fees.
Landlords can lower their taxable income with deductions for mortgage interest, property taxes, and other operating expenses. It's important to keep all records of these expenses.
Using your rental property for personal reasons or how long you've owned it can greatly affect your taxes. This includes dealing with capital gains tax and special rules for primary residences used as rentals.

Nearly 10 million Americans recorded rental income on their tax returns in 2020, according to the Internal Revenue Service (IRS). How many properties did those people own? An astonishing 17 million.

Whether you’ve recently joined their ranks or plan to do so sometime in the next tax year, there’s a not-so-minor detail you need to know: how the IRS taxes rental income. 

The short answer is that the IRS taxes rental income like ordinary income even if you have a mortgage. The longer answer is that there are several ways to reduce your taxable income from rentals, as well as a few situations that can impact how you file. 

Here’s what you need to know: 

How the IRS Taxes Rental Income

The IRS taxes rental income as ordinary income regardless of whether you have a mortgage. However, how you file those taxes is a little different. While you report your ordinary income on a W2, rental income is categorized as supplemental income. To report rental income, you must file a tax return using Schedule E on Form 1040. The IRS will then tax your rental income at the same rate as your regular income based on your tax bracket. 

Keep in mind, too, that reporting rental income doesn’t end with the rent checks. The IRS defines rental income as any payment you receive for the use of your property and can include: 

Nonrefundable deposits (e.g. security deposits)
Pet or cleaning fees 
Cancellation fees 

When you pay is also critical. If you expect to earn more than $1,000 in rental income, the IRS will require estimated tax payments. You can either pay quarterly (usually on the 15th of the first month of the quarter) or increase your W2 withholding to account for the rental income you expect to earn. 

Try Our Vacation Rental Pricing Tool

Use Smart Rates™ to optimize your pricing strategy.

Try here for free
How To Calculate Rental Income

Calculating rental income is particularly tricky for short-term rental (STR) owners, with fluctuating rates and occupancy and a lack of historical data to draw from. Many hosts calculate income in one of two ways: manually or using a vacation rental calculator.

1. Estimate STR Income Manually

A simple equation many STR hosts use to manually estimate their Airbnb revenue is multiplying the annual occupancy rate by the average daily rate (ADR) by 365 (for the number of days in a year). 

Using our data from Jackson Hole as an example: if the occupancy rate is 36% and the average daily rate is $409.50, you’ll multiply 409.5 x .36 x 365 for an estimate of $53,808.30 in total annual rental income. However, if your property is not available all year round, then you’ll want to take that into consideration.

2. Estimate Income With a Vacation Rental Calculator

Crunching the numbers on your own won’t always account for unexpected shifts in supply or demand that affect your rental income. An Airbnb calculator can offer extremely accurate revenue estimates by: 

Analyzing nearby properties
Creating an index based on relevance
Integrating critical market metrics like seasonality and occupancy 
Comparing your property to similar listings 

It’ll then project the total annual rental income based on the real performance of similar properties. You can use that estimate to calculate rental income tax for any given tax year. AirDNA’s Rentalizer also offers a monthly breakdown to help you dig deeper into the real revenue you can expect to earn.

Boost Your Rental Revenue

Tax Deductions You Can Use to Offset Rental Property Income

Deductions can reduce your tax liability, meaning the amount you’ll owe in taxes. Roughly 90% of taxpayers take the standard deduction, but itemizing your deductions can cut back your taxable income even further. 

This can be especially beneficial for STR hosts who incur any number of costs to operate their rentals. The nine tax deductions hosts most often take are: 

Mortgage interest payments: Your mortgage itself isn’t a deductible expense, but mortgage interest payments are.
Property taxes: Deduct any property taxes associated with your rental property.
Operating costs: This includes property management fees, costs for maintenance and repairs, and utilities. 
Travel: If you own multiple STRs and need to travel to them as part of your rental property business, you can deduct the expense of those trips. 
Home Office Expenses: Some STR hosts are hands-off, but if you’re managing your rental business from a dedicated location in your home, you can deduct a portion of your utilities and home insurance. 
Professional Fees: Many hosts work with lawyers, accountants, property managers, and more. The fees you pay for these types of services are usually deductible expenses. 
Advertising: If you pay to market your STR or list it on a site, those fees are also deductible expenses. 
Insurance: You can deduct the insurance premiums you pay for your rental coverage. 
Depreciation: As your property loses value due to wear and tear, you can deduct a fixed percentage of your taxable income to help with improvements. 

All of the above are acceptable tax deductions, but there’s one thing you have to get right before you can: documentation. If you get audited, the IRS will need a paper trail for every item you deduct. Save all receipts and invoices so you can verify your rental expenses if the IRS asks. 

Depreciation on a Rental Property

Depreciation happens when a rental loses market value. It can happen if the housing market shifts or simply due to the wear and tear of operating a rental. The good news is the IRS allows a depreciation deduction that you can collect as soon as your property is available to rent. 

You’ll meet the IRS’s criteria for depreciation if: 

You’re a property owner
The property is income-producing, e.g. an STR
The property will wear out over time
The property will last more than one year

If you check all the above boxes, you can deduct 3.636% of your taxable income for every year you own and operate your rental property. That deduction is the same amount rental properties tend to depreciate each year, and it covers the cost of improving the property. 

Personal Use of a Rental Property

Many real estate investors buy residential rental properties because they’d like to stay there themselves. While you don’t have to give up your favorite vacation spot to simplify your taxes, whether you personally use your rental property—and how you use it—can impact your taxes. 

The important thing is to determine whether the IRS will define your property as a rental or as a personal residence. To keep it in the rental category, consider: 

Days of Rental Use vs. Personal Use

Whether your property is considered a rental or a personal residence depends on how many days you use it yourself. If you use your STR for more than 14 days or more than 10% of the total days you rent it (whichever is greater), the IRS will tax it as a “mixed-use” property, meaning a property that you both rent out and use personally. 

Personal Residence With Rental Use

It’s not a bad thing if your property is categorized as mixed-use, but you do need to know how to file. Hosts with mixed-use properties must separate the expenses they incur while operating the property as a rental and those that arise while they use it personally. Come tax time, you can only deduct the portion tied to rental expenses.  

Loss Limitations

A net loss happens when your rental expenses exceed your rental income. How that impacts your taxes depends on how your property is classified. Personal residences aren’t eligible to deduct the net loss from their other income, but rental properties are. 

Why? A loss on a rental property is considered a passive activity loss, so you can only deduct it from passive income (e.g. rental property income) and not W2 income. 

Home Office Deductions

What if you don’t use your office to manage your rentals, but you do have a dedicated room or suite in your home that you rent out? You may be able to use that space to qualify for the home office deduction because the IRS often considers renting a room as “business use of home.” 

Market-Informed Pricing Decisions

AirDNA’s vacation rental pricing tool uses data-driven recommendations to propose the best daily rates.

Try it for free
Taxes That Apply When You Sell a Rental Property

New real estate investors often think they can sell a property and walk away with a sizable profit without looking back. However, there are several tax considerations when you sell a rental property. How much you’ll owe in taxes depends on how long you’ve owned the property, whether it’s classified as a rental or a personal residence, and how much you earned from the sale. 

If you sell, you’ll likely encounter:

Capital Gains Tax

This is the most common tax real estate investors face. The capital gain is the difference between the sale price and the adjusted value (usually the home value plus improvements and minus depreciation). 

If you owned the property for less than a year, it’s considered a short-term capital gain, and you’ll pay your normal income tax rate. If you owned the property for more than a year, it’s considered a long-term capital gain and your tax rate will typically be lower.

Depreciation Recapture

If you deduct depreciation from your taxable income, you may also have to pay depreciation recapture once you sell. The “recapture” is the amount of depreciation deductions you claimed or could have claimed. It’s typically taxed at 25%.

Net Investment Income Tax (NIIT)

NIIT is a 3.8% tax that typically applies to people with higher incomes. It applies to certain types of net investment property income (e.g. the net amount you earned from selling your property). Rental property owners that fall in this bracket typically pay an additional 3.8% tax on capital gains. 

1031 Exchange

Also called a tax-deferred exchange, this is a strategy to defer paying taxes. If you use the proceeds from your investment property to purchase another property within a certain period after the sale, you may be able to defer claiming your capital gains and therefore avoid paying both capital gains tax and depreciation recapture. 

Exclusion for Primary Residence

The tax rules are a little different if you’ve been operating your primary residence as a short-term rental. As long as the property was your primary residence for two of the last five years, you may be eligible for a capital gains exclusion, meaning the proceeds aren’t considered a capital gain and you don’t have to pay that tax on them. 

Run the Numbers Before You Invest

Short-term rental investing has a lot of silver linings, but there’s also plenty of red tape. While the above offers an overview of how rental property income is taxed, it’s also important to consult with a tax professional or accountant. Taxation can vary slightly from state to state, and you may be eligible for different deductions or exclusions based on your unique situation. 

Understanding your tax liability before you invest is critical, but so is how much revenue you can expect to earn. Estimate the revenue potential for any property, anywhere, so you can be sure the tax liability is worth it—both when you buy, while you operate, and if and when it’s time to sell. Learn more about investor tools from AirDNA. 

Customize Your Pricing
Try AirDNA for free

How Is Rental Income Taxed When You Have a Mortgage?

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