How Is Rental Income Taxed When You Have a Mortgage?

Rental income is taxable, but having a mortgage on the property can lower what you owe. You must report all rental income, but you can deduct expenses like mortgage interest, property taxes, insurance, maintenance and depreciation. These deductions can reduce your taxable income from the rental. A financial advisor could help you track these deductions and plan for your overall tax liability.

How the IRS Taxes Rental Income

When you earn money from renting property, the IRS considers this rental income, which is generally taxable. This includes not just the regular rent payments you receive from tenants. It also includes advance rent payments, non-refundable security deposits and any expenses that tenants pay on your behalf. The IRS taxes rental income differently than other types of income, following specific rules that property owners need to understand.

You must report rental income on your tax return in the year you receive it. For most individual landlords, this means including it on Schedule E (Supplemental Income and Loss) of your Form 1040. If you are active in a rental business rather than simply collecting passive income, you might need to report on Schedule C instead. Keeping detailed records of all rental transactions is essential for accurate reporting.

Short-term rentals and vacation properties have additional tax considerations. You do not need to report income if you rent your property for fewer than 15 days annually. However, this is not the case if you personally use the property and also rent it out. Instead, you will need to allocate expenses between personal and rental use.

Does Having a Mortgage Impact Your Taxable Rental Income?

When you own a rental property with a mortgage, the interest you pay directly impacts your taxable rental income. The IRS considers mortgage interest on rental properties a legitimate business expense. This means you can deduct these interest payments from your rental income before calculating your tax liability. This can potentially reduce the amount of rental income subject to taxation.

Not all mortgage payments affect your taxable rental income equally. Only the interest portion of your mortgage payment is deductible—the principal portion is not. As your mortgage matures, the proportion shifts from mostly interest to mostly principal. This means your deductible amount typically decreases over time. This gradual shift can increase your taxable rental income if your rental rates remain constant.

When combined with other allowable expenses like insurance, maintenance and property management fees, mortgage interest can help create a situation where you show positive cash flow from your rental while still reporting a paper loss for tax purposes. This tax advantage is one reason many real estate investors maintain mortgages even when they can pay off their properties.

How to Calculate Taxable Rental Income

A house with a "For Rent" sign on the front lawn.

When calculating taxable rental income, you will need to report all rental payments and advance rent. Also, include any expenses tenants pay on your behalf. The IRS considers these expenses income in the year you receive them, regardless of when they are earned.

To determine your net taxable rental income, you will need to subtract eligible expenses from your gross rental receipts. Common deductible expenses include mortgage interest, property taxes, insurance premiums, maintenance costs and depreciation. You can also deduct professional fees like property management services or legal consultations related to your rental property. Keeping detailed records of these expenses throughout the year will simplify your tax calculations.

The formula for calculating taxable rental income is straightforward: subtract your total deductible expenses from your total rental income. This net amount is what you will report on your tax return. This is typically done on Schedule E if you are an individual taxpayer.

Depreciation represents the gradual loss in value of your rental property over time. The IRS allows you to deduct this decrease in value as an expense, even though it does not involve an actual cash outlay. Residential rental properties generally depreciate over 27.5 years using the straight-line method. Including depreciation in your calculations can significantly reduce your taxable rental income.

Tax Deductions That Can Help Offset Rental Income

As a property owner, understanding available tax deductions can significantly reduce your tax liability on rental income. These deductions represent legitimate business expenses that the IRS allows you to subtract from your gross rental income before calculating your tax obligation.

Mortgage interest payments: The interest portion of your mortgage payments on rental properties is fully deductible. This often represents one of the largest deductions available to landlords. This is especially true during the early years of a loan when interest makes up the majority of your payment.
Property taxes: Local and state property taxes assessed on your rental property are deductible expenses. These annual taxes, which fund local services and infrastructure, can be substantial depending on your property’s location and value.
Insurance premiums: All insurance costs related to your rental property can be deducted. This includes landlord liability policies, fire, flood, theft and mortgage insurance premiums. These necessary expenses protect your investment as legitimate business costs.
Depreciation: The IRS allows you to deduct the cost of your rental property over time through depreciation. This non-cash expense recognizes that buildings deteriorate over their useful life, typically 27.5 years for residential properties. It provides a significant annual deduction without requiring additional cash outlay.
Repairs and maintenance: Ordinary and necessary expenses to keep your property in good working condition are deductible in the year you pay them. This includes fixing leaks, repainting, replacing broken windows and maintaining appliances or systems.

Bottom Line

Closeup of a "For Rent" sign in front of a home.

While you must report rental income on your tax return, mortgage interest payments are typically deductible as a business expense. This means the IRS only taxes you on your net rental income, or what remains after subtracting eligible expenses from your gross rental receipts. Beyond mortgage interest, you can also deduct property taxes, insurance premiums, maintenance costs and depreciation, significantly reducing your taxable income. Remember that proper documentation is crucial, as the IRS closely scrutinizes rental property deductions.

Tax Planning Tips

A financial advisor can help you organize your finances to prepare for tax time and lower your overall tax bill. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you want to know how much your next tax refund or balance could be, SmartAsset’s tax return calculator can help you get an estimate.