Learn how residential rental property income, expenses, basis, 27.5-year depreciation, personal use, and passive-loss rules work.
Residential rental property is real property that provides living accommodations and is held for producing rent. For federal depreciation, qualifying residential rental buildings are generally recovered over 27.5 years under the General Depreciation System using straight-line depreciation and the mid-month convention. Land is not depreciable.
The category can include a single-family home, condominium, apartment building, duplex, or a portion of an owner-occupied property. Tax treatment depends on ownership, when the property is ready and available for rent, personal use, services, basis, improvements, and activity limitations—not merely the address or lease length.
Report amounts received for the use or occupancy of the property. Rental income can include:
A refundable security deposit generally is not income when received if it may need to be returned. A deposit designated for the final month's rent is generally advance rent and taxable when received.
Ordinary and necessary rental expenses can include advertising, management fees, insurance, utilities, cleaning, maintenance, supplies, legal and professional fees, and qualifying travel or mileage. Mortgage interest and real property tax may also be deductible subject to applicable rules.
A repair generally keeps property in ordinarily efficient operating condition. An improvement that betters the property, restores it, or adapts it to a new or different use generally must be capitalized. Replacing a broken window may be a repair; replacing an entire roof is generally an improvement. The unit-of-property and safe-harbor rules can make the analysis more technical than the invoice label suggests.
Purchase price must be allocated between land and building. Land is not depreciated. Building basis generally includes the allocable purchase price plus capitalized acquisition costs and later improvements, adjusted for relevant items.
Suppose a landlord pays $650,000 for a duplex and a supportable allocation assigns $150,000 to land and $500,000 to the building. Her initial depreciable building basis is $500,000 before additional adjustments. She does not depreciate the $150,000 land allocation.
For property converted from personal use to rental, depreciation basis generally is the lower of adjusted basis or fair market value on the conversion date. Separate basis rules can apply when calculating a later loss, so preserve both original-basis and conversion-date records.
Residential rental buildings generally use a 27.5-year GDS recovery period, straight-line method, and mid-month convention. The property is placed in service when it is ready and available for rent—not necessarily when purchased, when the first tenant signs, or when rent is first collected.
Appliances, furniture, land improvements, and other components may have different recovery periods. A cost-segregation study may identify qualifying shorter-lived assets, but ordinary building structural components remain part of the 27.5-year building. Depreciation allowed or allowable reduces adjusted basis even if the owner fails to claim the deduction.
An individual generally reports rental real estate and royalties on Schedule E when services are customary for occupancy. If substantial services are provided primarily for tenant or guest convenience, Schedule C and self-employment tax may need analysis.
Partnerships and S corporations generally report rental activity on Form 8825 and pass items through on Schedule K-1. Entity ownership does not remove basis, at-risk, passive-loss, or state filing issues.
Mixed personal and rental use requires day tracking and expense allocation. If personal use exceeds the greater of 14 days or 10% of fair-rental days, the property is generally treated as used as a residence, and deductions can be limited under the vacation-home rules.
Otherwise allowable losses may then face owner basis limits, at-risk rules, and passive activity rules. Most conventional rental activity is passive unless a specific exception applies. Active participation may allow eligible taxpayers to use a limited amount of rental real-estate loss against nonpassive income, subject to modified adjusted gross income and other requirements.
Selling residential rental property can produce several tax components: gain attributable to land and building appreciation, unrecaptured Section 1250 gain related to depreciation, Section 1245 recapture on certain personal-property components, suspended-loss release, installment-sale issues, and possible like-kind-exchange treatment.
The sale price and selling costs should be allocated consistently among land, building, and separately depreciated components. A cost-segregation study can accelerate deductions during ownership but may increase ordinary recapture on shorter-lived assets at disposition.
California taxes rental income and generally permits ordinary and necessary rental expenses, but it does not conform to every federal depreciation provision. Federal bonus depreciation can create substantial differences in current deductions and remaining basis. California returns may require Schedule CA and a separate depreciation schedule, such as Form FTB 3885A for individuals.
California passive losses are calculated on Form FTB 3801. State carryforwards can differ from federal amounts because depreciation and basis differ. Property owners should keep federal and California schedules through the year of sale.
Heath Income Tax can help rental owners establish basis, classify expenses, track depreciation, and reconcile federal and California carryforwards.
Is every rental home depreciated over 27.5 years?
The residential rental building generally is, but land is not depreciated and qualifying furnishings, appliances, land improvements, or cost-segregated components may have different periods.
Can I deduct a loss if the rental had negative cash flow?
Not necessarily. Taxable income differs from cash flow, and personal-use, basis, at-risk, passive, and other limitations can delay a loss.
When does depreciation begin?
Generally when the property is ready and available for rent—its placed-in-service date.
The definitions and examples on this page are for informational purposes only and do not constitute tax advice. Tax laws change frequently and individual circumstances vary. Consult a qualified tax professional before making decisions based on this content.
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