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The list of things to think about as a landlord or rental property owner is extensive, with all kinds of financial decisions and moves to make regularly. Using real estate calculators can help you keep on top of things- including your rental income tax.
If you own a property and rent it to others, you may be wondering what tax you owe on the income generated through rental payments. Depending on the type of property you own, you may generate other income as well, but how is that taxed?
Rental income is viewed by state and federal law as taxable income, and unless you have rental losses for the year, you will almost definitely need to pay. Luckily for landlords, there are many ways to save- and an easy solution to help you calculate what you owe.
Working out how much tax you should expect to pay on income generated through rental property can be complicated, which is where a real estate rental income tax calculator (with depreciation) comes in handy.
In this comprehensive guide, we cover everything you need to know about how to calculate rental income tax, the things that impact the amount you owe, and what it means for your rental business. We have also shared a few examples to give you a better idea of how these calculations work in practice.
If you want to skip right ahead to working out your rental income tax, check out DoorLoop's fast and easy rental income calculator!
What Is Real Estate Rental Income Tax?
When you earn equity through an investment property, you are most likely to owe tax on it the same way you would any other ordinary income. Rental income tax is simply the money owed to the government on those earnings.
The IRS defines rental income as the money received for any service relating to the occupation of your property. That applies to residential rental property, commercial lets, and rented industrial spaces.
This includes the money landlords receive from their tenants in exchange for renting their property, but not just that. It also covers rental owners who take advance rent payments from the following year, hold security deposit funds, or have tenant services rendered in exchange for rent credits.
If you earn other income through a property, that is also taxable. Those who work in commercial real estate investing may earn revenue through advertising and parking fees, for example.
Rent payments and other property-related earnings are considered taxable income throughout the US, but the exact amount owed depends on the tax rates in your state and how much you earn.
Is Rental Income Taxed Differently for a Live-In Landlord?
In some cases, yes. Depending on how much you earn, you may be able to keep a certain amount of rental income tax-free as a live-in landlord. It is best to speak to a financial advisor about how this impacts you.
This guide focuses on rental income for those who own an investment property or multiple properties and rent them to others.
If you rent your home out for fewer than 14 days in a year, you do not usually need to pay tax on that income.
How Does Depreciation Impact Real Estate Taxes?
When you calculate your rental property taxes, you should include depreciation when relevant. Once your rental property is ready and available, it becomes eligible for depreciation for tax purposes.
Depreciation happens gradually (over 27.5 years for residential properties and 39 years for commercial real estate). It means lower taxes, so it is important to include this in the calculation.
Investors should note that depreciation only applies to the building, not the land value, which is why tax calculators for real estate ask for the land value as part of the calculation.
It works by taking the value of the property and deducting the value of the land. Then, the new total is divided by the number of years applicable to the property category to give the annual depreciation amount. This number is taken off the total of your rental property's taxable income.
Here is a simple example for each property type.
A residential property worth $300,000 with a lot value of $50,000 would be eligible for depreciation on $250,000. To find the annual depreciation allowance- you divide that number by 27.5 years.
- $250,000 ÷ 27.5 = $9090.90
You can deduct $9090.90 from your taxable income.
The same goes for commercial real estate, but split over 30 years instead of 27.5.
If a commercial property costs $600,000 and the lot is worth $150,000, the calculation for depreciation looks like this.
- $450,000 ÷ 30 = $15,000
The commercial property owner can take $15,000 off their taxable rental income.
How Is Real Estate Rental Property Income Tax Calculated?
Rental income is taxed at the same rate as ordinary income. Whatever tax bracket applies to your salary or other earnings will also apply to your rental tax payment.
If we look at a very simple example, a property investor who is in a 30% tax bracket and earns $200,000 in rental income each year would pay $60,000 in tax ($200,000 x 30%).
Of course, the calculation is a little more complicated than that, and there are many other things that come into play. These include your deductible expenses, depreciation rate, property value, and mortgage interest rate.
The Variables: What Affects Rental Income Tax?
Before we look into rental income tax calculators and how to use them, let's take a closer look at the variable in the equation.
Property Purchase Price and Land Value
The amount you paid for (or expect to pay for) a property matters for tax purposes because of depreciation. Your property's purchase price determines how much you can deduct from the taxable income annually.
Land values are established through in-depth surveys based on many factors. These include the neighborhood, land square footage, the level, and much more.
Your Monthly Rent Charge and Other Income
How much you generate through rent and other sources of income related to your property are other major factors in calculating your rental income. The calculator will ask you to input the gross monthly rental income earned and the total of any other income.
As you can probably imagine, the more money your property earns, the more income tax you will need to pay- such is the way of the world.
Mortgage Interest Rate
The interest included in each monthly mortgage payment is tax deductible for rental property owners.
As long as you pay more than $600 in interest annually through your monthly mortgage payments, your lender should send you a summary of the total amount within a month or two of the new year. You can use this to secure a deduction on your rental income tax.
Interest paid on other loans relating to the property (renovations, etc.) may also be deductible from your income tax payment.
You may also be able to deduct closing costs from your rental property tax, but this varies between properties. Costs, including the loan origination fees and sales tax, may be tax-exempt depending on your effective tax rate, overall income, and property cost.
Monthly Expenses
You can also deduct some of the monthly expenses from your rental income tax- not 100% of everything, but it can still make a difference.
By inputting your monthly maintenance costs and other expenses, you get closer to your net operating income rather than gross rental income.
Net operating income simply means the remaining positive cash flow after the operating expenses. Many of these count as business expenses and are tax-deductible, like a business expense would be in any other line of work.
Some of the things you can include are insurance, property taxes, maintenance and repair costs, and equipment purchases (new HVAC systems, for example).
There are also several expenses that are not deductible. These include inspection costs, flood and fire insurance, appraisals, legal fees related to appraisals and inspections, mortgage refinancing, and the costs involved in reporting credit.
Your Effective Tax Rate
Your effective tax rate is technically the average amount of tax you owe as a percentage. It varies depending on your total earnings and how those earnings are classified.
The tax bracket that applies to your other income also applies to your rental income. You will be taxed at the same rate on any earnings that qualify. If you are a high earner with a high effective tax rate outside of real estate, it still applies even if you only earn a small amount of rental income.
How to Use an Income Tax Calculator for Rental Properties
Taking all of that into account, let's look at how a rental income tax calculator works. The purpose of using a calculator to work out your rental income tax is to make things simpler for you. Instead of getting out your pencil and calculator, you can quickly input the details and get the results in seconds.
An income tax calculator for real estate works by taking your rental income, tax rate, deducted expenses, and depreciation to give you an estimated annual bill.
The formula used is essentially as follows:
Rental Income Tax = (Gross Earnings - Relevant Expenses - Depreciation Deduction) x Effective Tax Rate
Let's take a closer look at how to use the calculator.
It starts by asking for the details of your property purchase price (or expected purchase price) and the value of the land. This covers the depreciation recapture for your tax calculation. Based on the timeframe of depreciation for your property type, the calculator will automatically apply it to the outcome.
Next, it will ask for your incoming cash flows- specifically the monthly rent payments you take and any other earnings generated through the property. You should put in the gross monthly rental income, not the net income, as the expenses will be calculated in the next step.
The final stage looks at your expenses and property tax details- including your mortgage interest payment, maintenance costs, other relevant expenses, and effective tax rate.
Using the figures you provide, the calculator works out your net operating income a expected rental income tax payment. Some calculators also cover the cap rate and return on investment (ROI).
Example of a Rental Income Tax Calculation
Let's have a look at what all that information looks like in practice for rental property investors.
In this example, a property management company has a residential apartment block valued at $400,000. The lot itself is worth $40,000. Between all the units, the annual rental income is $200,000. There is no other income generated through the property. Let's say the tax bracket is 30%.
First, we will share a basic example without deductions or depreciation recapture.
Based solely on the income and tax bracket, the calculation would look like this:
- $200,000 x 30% = $60,000
The property owners would owe $60,000 in rental income tax.
In a real-life situation, the calculation would be more complex. To show what this may look like, let's now include some of the deductions that would apply to this property.
Hypothetically, let's say the real estate investors, in this case, have the following deductible expenses.
- 1% property tax at $4,000
- $10,000 in annual insurance costs
- $20,000 in annual mortgage interest payments
- $5,000 of advertising expenses
- $12,000 worth of maintenance and repair costs
- $5,000 worth of equipment purchases
The total of these expenses is $56,000, but they are not 100% tax deductible. Exact amounts can vary, but let's say for this example that $40,000 is. That makes the taxable income:
- $200,000 gross rental income - $40,000 deductible expenses = $160,000
From there, the tax calculation would look like this:
- $160,000 x 30% tax rate = $48,000
Finally, we need to account for depreciation. Since this is a residential property, the depreciation recapture spans 27.5 years- but only on the property value itself, minus the land value.
As stated earlier in the example, the property purchase price was $400,000, but the lot accounts for $40,000 of that. That gives us $360,000 to calculate for depreciation.
To find the annual depreciated value, the calculator divides $360,000 by 27.5 years.
- $360,000 ÷ 27.5 = $13,090.91
This amount also comes off your taxable income, making the new total $146,909.09.
The final rental income tax calculation is:
- $146,909.09 x 30% = $44,047.72
With expenses and depreciated value included in the calculation, the annual income tax bill for this property would be $44,047.72.
How Is Rental Income Tax Leveraged in Real Estate?
The reason for this calculation is to know how much tax you should expect to pay on your rental income as a real estate investor. People use it to estimate costs on properties they already own and plan on renting and to help them decide if they want to add a particular property to their portfolio.
What Is a Good Amount of Rental Income Tax to Pay?
There is no good or bad amount of rental income tax- it is based on the government tax rate applied to your earning bracket. As long as you put in the correct details and don't forget to take advantage of as many tax deduction opportunities as possible, you can get the rate you should have.
Understanding what you can and cannot deduct from your taxable rental income is the key to getting the best outcome for your annual bill.
Are There Any Limitations to Know About When Using an Income Tax Rental Property Calculator?
Rental property income tax calculators base their calculations on the numbers you provide, so they must be accurate if you want a reliable estimate. It is also important to remember that the figures provided are just that- an estimate.
What you can and cannot deduct from your taxable income depends on several factors, and not all real estate investors have the same options and allowances. To find out exactly how much you can deduct, you need to apply via the IRS.
Other Things to Consider
As a landlord or rental property investor, you may also have to pay capital gains tax if you sell your property. This is different from rental income tax, as it only applies after a sale if you earn a profit. Capital gains taxes affect property investors selling properties, but you don't need to worry about them annually the same way you do with rental income tax.
Always remember to stick to key tax dates to avoid late fees and penalties. April 15th is the most important date in the calendar.
If you are calculating the estimated rental property income taxes for a property you are interested in buying, you should use the current market value as the basis for the purchase price.
Rental income also applies to short-term rentals such as Airbnbs if you rent it for more than 14 days of the year or live in the property yourself more than 10% of the days it is rented (for example, if you rent it for 250 days but live in it yourself for more than 25). Some of the rules may be a little different, but the basic calculation is the same.
It is worth taking the time to look into the complete list of deductible expenses before calculating your rental income taxes. There are more than 30 categories, from investment research expenses to legal costs in an eviction.
You can significantly reduce your bill by utilizing all the tools available to you. A tax professional advisor may be able to tell you more about what you can claim back to help minimize your payments.
How Can DoorLoop Help?
Where does DoorLoop come into the equation? To start, DoorLoop calculators provide a range of financial insights to help real estate investors make more informed decisions and maximize their profitability. One of those tools is a rental income tax calculator that helps with the topic in question.
Using these tools gives you a better understanding of your investments, potential purchases, and other financial choices in the real estate business. If you want a better way to plan and prepare for an initial investment or to manage your existing portfolio, this is the place to do it.
It doesn't stop at just the calculators- DoorLoop has much more to offer. There is no more efficient and streamlined method for property management than the DoorLoop software. Every angle of operating a rental business is covered, and then some, with tools to help you every step of the way.
Some of the standout features include:
- A full suite of accounting tools to help you manage your finances and prepare your tax payments and tax returns
- Online payment collection systems to manage rental cash flow
- Streamlined property maintenance management through an online communications system
- Advanced tenant screening support- including calculators for verifying income
- Marketing for rental properties through Zillow and Trulia
- Custom application website for your potential renters
- Convenient and efficient property portfolio management- from vacancy tracking to lease agreements
- Much, much more!
The ways DoorLoop supports landlords and property management companies are endless, and you can experience it yourself by scheduling a free demo. Explore the software and learn more about the difference DoorLoop could make for your business.
Summary
As a rental property manager, owner, and investor, you have a lot of things to think about. All are important, but staying on top of your taxes is vital. Being prepared for the bills and having an idea of what you should expect to pay can help you get your finances in order and keep your business running smoothly.
The most important things to remember about rental property income are your deductibles and depreciation- you don't want to pay any more than you have to! Using a real estate income tax calculator is the fastest and easiest way to work out an estimate of what your costs will be, and DoorLoop is the best place to start.
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