Rental Income: Landlord's Guide to Schedule E on Form 1040

If you're a landlord, understanding Schedule E income is crucial for accurately reporting rental income, losses, royalties, and other real estate-related income. This guide breaks down the key aspects of Schedule E, including how to report rental income, offset losses, and navigate tax rules.

How to Report Rental Property Income & Expenses

To report rental income and expenses, use Schedule E on your tax return.

• Depreciation & Amortization: Use Form 4562 if you’re claiming depreciation, including a Section 179 expense election.

• Hotel-Like Services: If you provide daily room cleaning or short-term business rentals, report this income on Schedule C instead.

• Real Estate Professionals: If you qualify as a real estate professional, you can report all rental income on Schedule C (instead of Schedule E). You must meet two conditions:

  1. More than half of your services must be in real property trades.

  2. You must perform 750+ hours of services in those trades annually.

Offsetting Rental Losses with Passive Loss Rules

Rental losses are generally limited under passive activity loss rules, but exceptions exist.

• If you or your spouse actively participate in rental real estate, you may deduct up to $25,000 in rental losses—even with passive loss limitations.

• Active participation includes making key management decisions such as:
  ✅ Approving new tenants
  ✅ Setting rental rates
  ✅ Authorizing property expenses

Example: Using Rental Losses to Offset Income

Let’s say you earn:
💰 $70,000 from W-2 wages
💰 $15,000 from a limited partnership
💸 $20,000 loss from rental real estate activities

If you actively participated in managing the rental, you can offset $11,000 of rental losses against your wages, reducing your taxable income.

Other Rental Income & Expense Considerations

📌 Net Investment Income Tax
Rental income is subject to the 3.8% net investment income tax if it’s considered a passive activity.

📌 Security Deposits

• Not taxable unless forfeited by the tenant.

📌 Lease Cancellation Payments

• Considered rental income when a tenant pays to terminate a lease early.

📌 Tenant-Provided Services

• If a tenant performs work (e.g., painting in exchange for rent), the value of the work is taxable rental income.

📌 Rental Property Conversions

• If you convert a former home into a rental property, the depreciable basis is the lower of:

  1. The fair market value at conversion

  2. The adjusted basis (original purchase price + improvements - depreciation).

📌 Inherited & Gifted Properties

• Gifted Property: Basis is carryover basis if the fair market value is equal to or greater than the donor’s adjusted basis.

• Inherited Property: The basis is the fair market value at the time of the owner’s death.

Partial Rental Use & Rental Losses

If you use a rental property for personal and rental purposes, expenses must be allocated based on the ratio of rental days to total usage days.

📌 Special Rule: If you rented your home for less than 15 days during the year, the rental income is tax-free, and expenses cannot be deducted.

📌 Profit Motive: If the IRS challenges your rental losses for lack of profit intent (e.g., short-term rentals before moving), you may need additional documentation to support deductions.

Need Expert Guidance? Consult a Tax Professional!

Navigating rental income, expenses, and tax deductions can be complex. Consult a Houston tax professional to ensure:
✔ Accurate reporting on Schedule E
✔ Proper loss deductions under passive activity rules
✔ Compliance with real estate tax laws

📞 Contact Arnold CPA today for expert tax guidance!