How Does the IRS Know If I Have Rental Income?
Written by Jonas Bordo
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.
However, there are also several tax deductions you can take advantage of. Deductible expenses include mortgage interest, operating expenses, property taxes, repairs, and depreciation.
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.
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.
However, rental income is typically classified as passive activity income rather than wages, so it’s generally not subject to self-employment tax unless you provide services that qualify you as a real estate professional.
A tax professional can help you understand how tax rules apply to you and maximize your deductions.
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. 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.
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