Many people earn extra money by investing in property that can be leased to tenants and generate monthly rental income, while for others, it’s their main source of income and they manage it as a business. Either way, the rental income needs to be reported on your tax return. When reporting, however, you don’t report it in the same way as your investment income.

Rental Vs. Investment Income

The term “investment income” generally refers to financial investments, such as capital gains from the sale of stocks and bonds, interest payments and dividends, to name just a few. Rental income, however, is in a category all by itself. You won’t pay income tax on the gross amount of rental income you earn; rather the Internal Revenue Service allows you to offset it with the expenses related to generating the rental income.

Rental Property Deductions

Expenses you can deduct from your rental income cover the typical expenses that all homeowners generally incur, such as mortgage interest and property taxes. However, rental income deductions include many other expenses. If you hire companies to clean the interior of the home or building, use landscapers to cut the grass in the summer or have a maintenance person on premises – all these costs are deductible. You can also deduct insurance, the cost of advertising properties to prospective tenants, fees you pay to a management company that oversees the day-to-day rental operations and even annual depreciation deductions for a portion of the property’s acquisition cost.

Reporting Rental Income

In most cases, rental income and deductions are reported on a Schedule E attachment to your personal return. This remains true even if the rental activities are conducted through an S-Corp or partnership since your share of income through these business structures are ultimately reported on a Schedule E as well. For individuals who manage their rental properties as a trade or business or who actively participate in rental activities by providing services, such as changing tenant bed linens each day, you will then report all rental income and deductions on a Schedule C instead.

Limitation on Losses

For any year that your rental expenses exceed rental income, you’ll need to be aware of the “at-risk” and “passive activity” rules – both of which limit how you can use the loss to offset non-rental income. The at-risk rules don’t allow you to reduce non-rental income with any rental loss that in excess of your total investment in the property. In addition, the IRS treats rental income as a passive activity, unless you operate rental business that requires a substantial amount of your time. The passive activity rules work in conjunction with the at-risk rules and only allow you to offset of types of passive income with a rental loss. However, if you’re eligible to report your rental activities on a Schedule C, the income is still considered passive but you can use up to $25,000 of rental losses to offset non-passive income reported on your return, such as employment income.