How is Rental Income Taxed

For individuals venturing into real estate investment, understanding the tax implications of rental income is crucial. Rental income is classified as passive ordinary income for tax purposes. Unlike income from self-employment, rental income is not subject to self-employment tax. And unlike income from your W2 job, it is not subject to payroll taxes.

Passive Ordinary Income: Rental income falls under the category of passive income. This comes with the benefit of not having additional payroll or self-employment taxes, but also the downside of potential limitations on any losses incurred. Unlike losses incurred from self-employment which can offset other taxable income sources, losses from long-term passive rentals can not offset other taxable income except in a few exceptions.

1. The taxpayer’s AGI is < $100,000 (if between $100k and $150k a partial loss deduction is allowed) allows for up to $25,000 of passive rental losses to offset other taxable income

2. The taxpayer is qualifying real estate professional-which creates the assumption of their rentals being non-passive

3. The property is a short-term rental with an average guest stay of 7 days or less and the taxpayer material participates. This circumstance also allows classification as non-passive.

Normal Ordinary Tax Rate: The tax rate applied to rental income is determined by the individual's overall taxable income and corresponding tax bracket. Rental income is aggregated with other sources of income, such as wages, interest, dividends, and capital gains, to calculate the taxpayer's total taxable income. The income tax rates vary depending on the taxpayer's filing status (single, married filing jointly, etc.) and total taxable income.

Tax Deductions and Benefits: Property owners can offset taxable rental income by deducting various expenses associated with owning and operating rental properties. These deductions may include mortgage interest, property taxes, insurance, maintenance and repairs, depreciation, and property management fees. Additionally, certain tax benefits, such as the pass-through deduction for qualified business income (Section 199A deduction) apply to any rentals that rise to the level of a trade or business (regardless of if the safe harbor is met). It’s important to note that it is the net amount of income or loss after these deductions that is taken into account.