Depreciation alone can shelter $5,000–$10,000 of rental income from taxes every year — with no cash outlay. Combined with mortgage interest, repairs, and management fees, many landlords show a tax loss while actually pocketing cash. Here is how every deduction works.
How Rental Income Is Taxed: Schedule E Overview
Rental income and expenses are reported on Schedule E (Supplemental Income and Loss), which flows to your Form 1040. Unlike Schedule C (self-employment), rental income is generally passive income — which affects how losses are treated.
You report:
- All rental income received (rent, late fees, pet deposits kept, services in lieu of rent)
- All deductible expenses
- The resulting net rental income or loss
The Complete List of Rental Deductions
Mortgage Interest
Deduct all interest paid on your rental property mortgage. This is typically your largest cash deduction in the early years of ownership. Reported directly on Schedule E (not Schedule A). Include interest from:
- Primary mortgage
- Home equity loan or HELOC used to fund the property
- Second mortgages on the rental
Property Taxes
Real estate taxes assessed on the rental property. Fully deductible. Special assessments for local improvements (new sidewalks, sewers) may need to be capitalized if they add permanent value.
Insurance Premiums
- Landlord/rental property insurance
- Fire, flood, earthquake insurance
- Umbrella liability insurance (prorated for business use)
Not deductible: life insurance on yourself, health insurance (deducted elsewhere if self-employed).
Depreciation: The Biggest Non-Cash Deduction
Depreciation is the IRS’s acknowledgment that buildings wear out. For residential rentals, the straight-line depreciation period is 27.5 years.
How to calculate:
- Determine total purchase price + closing costs
- Allocate between land (not depreciable) and building (depreciable)
- Divide building value by 27.5
| Purchase Price | Land Value | Building Value | Annual Depreciation |
|---|---|---|---|
| $150,000 | $25,000 | $125,000 | $4,545 |
| $200,000 | $35,000 | $165,000 | $6,000 |
| $250,000 | $45,000 | $205,000 | $7,455 |
| $350,000 | $60,000 | $290,000 | $10,545 |
| $500,000 | $80,000 | $420,000 | $15,273 |
Land allocation: The IRS does not set a formula. Use the county property tax assessment ratio (land value ÷ total value) as a reasonable approximation. Your accountant can use a cost segregation study for more precise allocation on larger properties.
Repairs and Maintenance vs. Improvements
| Deductible as Repair (Expense This Year) | Must Capitalize (Depreciate Over Years) |
|---|---|
| Fixing a leaky faucet | Replacing all plumbing |
| Patching roof leak | Full roof replacement |
| Repainting interior | Adding a room |
| Replacing broken window | Replacing all windows (upgrade) |
| Fixing appliance | Replacing all appliances |
| Unclogging drain | Adding a deck |
Safe harbor rule: Items costing under $2,500 per invoice can generally be expensed immediately under the de minimis safe harbor — even if they would otherwise be improvements. Keep invoices.
Property Management Fees
Fully deductible — typically 8–12% of monthly rent. Includes:
- Management company fees
- Leasing fees (typically 50–100% of first month’s rent)
- Maintenance coordination fees
If you self-manage, you cannot deduct the value of your own time — only cash expenses.
Advertising and Tenant Acquisition
- Listing fees (Zillow, Apartments.com)
- Signage
- Photography for listings
- Background check fees you pay
Utilities You Pay
If you pay any utilities on behalf of tenants (common in some lease structures):
- Water, gas, electricity, trash
- Internet (if included in lease)
Legal and Professional Fees
- Attorney fees for lease drafting, eviction, or disputes
- CPA fees for rental property tax preparation
- Bookkeeping fees
HOA Fees
If the rental is in an HOA, monthly and special assessment fees are deductible as operating expenses.
Travel to the Property
Transportation costs to visit the rental for management purposes (inspections, tenant meetings, showing the unit):
- Standard mileage rate: 70 cents/mile (2026)
- Long-distance travel: airfare, hotel, 50% of meals
You must document the business purpose of each trip. Personal trips to the property (even to make repairs) that are primarily vacation do not qualify.
The Passive Activity Loss Rules: When You Can Deduct Losses
Rental real estate is classified as passive activity. Passive losses can generally only offset passive income. However, there is a special allowance for active participants:
| AGI Level | Allowance |
|---|---|
| $100,000 or below | Deduct up to $25,000 rental loss against ordinary income |
| $100,001–$149,999 | $25,000 allowance phases out $0.50 per $1 above $100K |
| $150,000+ | No rental loss against ordinary income; carry forward |
“Active participation” is a low bar — it means you make management decisions (set rents, approve tenants, authorize repairs). You do NOT need to be a real estate professional.
Real estate professionals (750+ hours/year in real estate and more time in real estate than any other profession) can deduct all rental losses against any income — there is no $25,000 cap.
Example of Loss Allowance
| Amount | |
|---|---|
| Rental income | $18,000 |
| Operating expenses | −$8,000 |
| Depreciation | −$7,273 |
| Mortgage interest | −$9,500 |
| Net rental loss | −$6,773 |
| Your AGI (from W-2) | $95,000 |
| Loss deductible against W-2 income | $6,773 (AGI under $100K) |
| Tax savings at 22% + 5% state | $1,829 |
Depreciation Recapture on Sale
When you sell, the IRS taxes back the depreciation deductions you took. This is called unrecaptured Section 1250 gain and is taxed at a maximum rate of 25% (not the standard 0–20% LTCG rate).
Example: Sell after 10 Years
| Amount | |
|---|---|
| Purchase price | $220,000 |
| Total depreciation taken (10 years × $6,545) | −$65,450 |
| Adjusted basis at sale | $154,550 |
| Sale price | $310,000 |
| Total gain | $155,450 |
| Depreciation recapture portion (taxed at ≤25%) | $65,450 |
| Remaining gain (taxed at LTCG rates, 0–20%) | $90,000 |
Strategy to defer recapture: A 1031 exchange defers both the regular capital gain and the depreciation recapture into the next property — indefinitely. See the full 1031 exchange guide for rules, timelines, and QI requirements.
Recordkeeping Requirements
The IRS can audit rental returns up to 3 years after filing (6 years if income is understated by 25%+). Keep:
- Closing documents (establish original basis)
- All expense receipts
- Depreciation schedules (Form 4562)
- Lease agreements
- Mileage log
- Bank statements showing rent deposits
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