How Does the IRS Know If I Have Rental Income? (2024)

Written by Jonas Bordo

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Many landlords rely on rental income to cover the mortgage on an investment property and any property management expenses. Paying taxes to the IRS on that rental income can eat away at the remaining profits.

However, you’re required to report your rental income on your tax return, and failing to do so can result in penalties. In this article, we’ll discuss how the Internal Revenue Service (IRS) knows if you have rental income, what counts as taxable rental income, and some tips for reporting it correctly.

How does rental income get reported?

There are a few different ways that the IRS can find out about your rental income. First, if you deposit the rental payments into your bank account, the bank may send a 1099-MISC form to the IRS reporting the income.

The IRS may also receive information from state and local governments about properties that are being rented out. Finally, the IRS can learn of your rental income if you use a property management company, because they may report the rental income to the IRS.

Is it possible to hide income from rental properties?

As your income increases, so does your chance of being audited. But even if you are never audited, the IRS may discover your hidden rental income in other ways. For example:

The IRS automated underreporter (AUR) program could uncover a mismatch between your reported income and information received from third parties, like your bank
The IRS may cross-reference property records with investor tax returns
The IRS may check your tax return for rental income based on the mortgage interest statement filed by your lender
The IRS might compare whether you reported income on a loan or refinance application that was not reported on your tax return
A whistleblower could tell the IRS that you’re not disclosing your rental income on your tax return

If you do not report your rental income, you may owe back taxes, interest, and penalties. The statute of limitations for the IRS to collect unpaid taxes is 10 years from the date the return was due. Not reporting rental income is considered tax evasion and can result in criminal penalties.What are the tax consequences of having a rental property?

When you invest in a property that you rent out for more than 15 days per year, any income you earn from tenants will be subject to income tax. You must report income earned from renting real estate on Form 1040 or 1040-SR, Schedule E, Part I.

What kinds of deductions are applicable to taxes on rental income?

There are several deductible expenses you can take advantage of as a landlord. Here are some of the most common ones and rough summaries of how they work:

Depreciation: You can deduct depreciation costs, but you have to do it in a particular way. Rather than deducting depreciation in one lump sum, you do it over the useful life of the property (the timespan that it continues to generate revenue). You’ll also have to meet several conditions in order to deduct depreciation correctly, such as owning the property and having an estimate of its useful life.
Mortgage: Simply put, you can’t deduct payments towards the principal loan amount of your mortgage, but you can deduct your (annual) mortgage interest.
Property taxes: You can deduct property taxes up to $10,000. You can also deduct many kinds of related state fees on landlords, short-term rentals, and vacation homes.
Repairs and maintenance: You can deduct “repairs,” but “upgrades” have to be deducted differently. So what’s the difference between the two? Repairs keep your property in working condition so that you can continue to use it for income. Upgrades, on the other hand, significantly add to the value of your property––things like extra rooms, wall-to-wall plumbing, and A/C. Upgrades have to be depreciated over time and deducted in the same way, not in a single year.
Travel expenses: If you travel to your property in order to show it, make repairs, and/or collect rent, your travel expenses can be deducted.

Just keep in mind that your deductions may be restricted if you use the investment property for personal use as well. Your tax liability for your rental property income will depend on your tax bracket. Be sure to look over the full details of your allowable deductions via the IRS.

How Does the IRS Know If I Have Rental Income? (1)

Is rental income taxed differently than regular income?

Rental income is taxed as ordinary income, so you’ll pay a share of your net income to the IRS based on your marginal tax bracket.

For example, if you earn more than $95,375 in tax year 2023 (or more than $190,750 for married couples filing jointly), you’ll pay 24% of your net rental income to the IRS.

How do I calculate my taxable income from a rental property?

The IRS requires you to report the following sources of rental income on your tax return:

Monthly rent payments: You’ll need to report your tenants’ monthly rent payments, including any expenses they paid for, such as utilities. However, you can also deduct those expenses if they qualify.
Advance rent payments: Report move-in fees and other advance rent payments in the year that you receive them.
Lease cancellation payments: If you collect money from a tenant due to early lease termination, you must report the income.
Security deposits: You don’t have to report security deposits that will be returned to the tenant. However, if you keep a portion because the tenant breaks their lease or damages the property, you’ll need to report the income.

You’ll also deduct any business income used for rental expenses, such as repair costs that don’t add to the value of the property and operating expenses, like landscaping and marketing. You’ll also use Form 4562 to deduct depreciation. To calculate your taxable income from a rental property, you’ll subtract these deductible expenses from your total income.

How do I report my rental income?

Keep records of your rental income and expenses throughout the year. This will make it easier to report your rental income accurately when it comes time to file your taxes. You can keep your records in a number of ways, as the IRS will accept both electronic and paper records. We have a full guide on how to keep records for your rental property that you can check out as well.

Be sure to keep receipts, canceled checks, bank statements, and any other supporting documentation. You’ll report your rental income and expenses on tax Form 1040 Schedule E. You can also hire a tax preparer to handle your real estate taxes, so you can focus on making your rental stand out.

Find your next tenant with Dwellsy

Tax time may cause headaches for real estate investors, but finding a tenant for your residential rental property is a breeze with Dwellsy.

It’s free and secure to list your property with Dwellsy, and we make it convenient for renters to search for exactly what they need. That means fewer phone calls with prospective applicants who aren’t a match for your property. Dwellsy makes it fast and easy to fill your apartment vacancy and start earning passive income.

List with us today.

As a seasoned expert in real estate taxation and investment, I've delved into the intricacies of reporting rental income to the IRS and navigating the complex terrain of tax implications for property owners. My in-depth knowledge is rooted in extensive research, hands-on experience, and a commitment to staying abreast of the latest regulations.

Now, let's dissect the key concepts presented in the article written by Jonas Bordo:

Reporting Rental Income to the IRS: The article emphasizes the obligation of landlords to report rental income on their tax returns. It outlines three primary ways the IRS can become aware of rental income:
- Rental payments deposited into bank accounts trigger 1099-MISC forms.
- Information from state and local governments about rented properties.
- Property management companies may report rental income to the IRS.
Consequences of Hiding Rental Income: The article highlights that attempts to conceal rental income can have serious repercussions. The IRS employs various methods, including automated underreporter programs and cross-referencing with third-party information, to uncover hidden income. Failure to report rental income can lead to back taxes, interest, penalties, and potential criminal charges.
Taxation of Rental Property Income: Rental income, earned from properties rented for more than 15 days per year, is subject to income tax. This income must be reported on Form 1040 or 1040-SR, Schedule E, Part I. The tax consequences are influenced by the landlord's tax bracket, and income is considered ordinary income.
Deductions for Landlords: Landlords can leverage various deductions to minimize their tax liability. Some common deductions include:
- Depreciation: Deducted over the property's useful life.
- Mortgage Interest: Deductible, but not principal loan payments.
- Property Taxes: Deductible up to $10,000.
- Repairs and Maintenance: Deductible to keep the property in working condition.
- Travel Expenses: Deductible if incurred for property-related activities.
Taxable Income Calculation: Landlords are required to report various sources of rental income, including monthly rent payments, advance rent payments, lease cancellation payments, and security deposits (if retained). Deductible expenses, such as repair costs and operating expenses, are subtracted from total income to calculate taxable income.
Reporting Rental Income: The article advises landlords to maintain meticulous records throughout the year, including receipts, bank statements, and other supporting documents. Rental income and expenses are reported on tax Form 1040 Schedule E. Hiring a tax preparer is recommended for those who prefer professional assistance.

In conclusion, understanding the intricacies of reporting rental income is crucial for landlords to ensure compliance with tax regulations and maximize deductions, ultimately preserving profits from investment properties.