IRC §469 · §280A · IRS Pub 527 · Schedule E · TY 2026
Most residential rental income is reported on Schedule E. Depreciation runs 27.5 years on the building only. The passive loss rules, the §280A 14-day rules, and the depreciation recapture trap at sale are where first-time landlords lose the most money. Here is the full mechanics for tax year 2026.
Estimate your Schedule E net income, depreciation, the $25,000 passive loss allowance, and NIIT exposure in one place.
Run the Rental Income Tax Calculator →Most residential rental income is reported on Schedule E (Form 1040). Gross rents are taxable. From that, you deduct mortgage interest, property tax, operating expenses (repairs, insurance, utilities, advertising, management fees), and depreciation on the building over 27.5 years using straight-line MACRS GDS. Net income is taxed at your marginal federal rate; net loss is generally a passive activity loss limited under IRC §469, with a $25,000 special allowance for active participants whose modified AGI is under $100,000 (phasing out at $150,000). Special exceptions can change everything: rent fewer than 15 days under §280A and report nothing; qualify as a real estate professional under §469(c)(7) and rental losses become non-passive; run a short-term rental with average stays of 7 days or less plus material participation and the activity escapes the rental classification. Depreciation is mandatory each year and is recaptured at sale at a maximum 25 percent rate under §1250.
Most residential rental income is reported on Schedule E (Form 1040), Supplemental Income and Loss. Schedule E is the default for property owners who lease out a single-family home, condo, duplex, or other residential dwelling without providing meaningful additional services. The income flows from Schedule E to Schedule 1 line 5 and finally to Form 1040 line 8.
Schedule E itself is straightforward in structure. You list the property (address, type, days rented, days personal use), report gross rents on line 3, and itemize deductible expenses on lines 5 through 19. Each property is its own column; you can list up to three properties on a single Schedule E and use additional copies for more.
If you provide substantial services to your tenants - daily cleaning, meals, transportation to and from the property, organized events, concierge - the activity is treated as a trade or business, not a passive rental, under IRS Topic 414. The activity reports on Schedule C (sole proprietorship) and is subject to self-employment tax of 15.3 percent on the first $184,500 of combined wages and SE income (2026 wage base) plus 2.9 percent above that. Hotel-style operations always go on Schedule C.
The line between "ordinary" and "substantial" services is fact-specific. Providing utilities, garbage collection, and routine maintenance is ordinary (Schedule E). Providing daily housekeeping, meals, and concierge is substantial (Schedule C). Most Airbnb operations that do nothing more than supply a clean property between guest stays remain on Schedule E even at high turnover frequencies.
Depreciation is the mechanism for recovering the cost of the building over its useful life. For residential rental property, the IRS-prescribed recovery period is 27.5 years under MACRS General Depreciation System (GDS), straight-line method, mid-month convention. There is no choice; this is the mandatory schedule under IRS Publication 946.
Land is not depreciable because it does not wear out or become obsolete. Only the building (and improvements, fixtures, structural components) is depreciable. The first task for a new landlord is allocating purchase price between land and building. The standard methods:
Typical residential building/land ratios run 75-85 percent building, 15-25 percent land. In high-cost coastal markets the land share can be much higher; in inland areas it is often lower. There is no IRS-published "correct" ratio; the standard is a reasonable, supportable allocation.
Annual depreciation = Building basis ÷ 27.5
For a $350,000 purchase with $70,000 land allocation, building basis is $280,000. Annual depreciation is $280,000 / 27.5 = $10,182. That deduction is taken every year for 27.5 years on Schedule E line 18, reported through Form 4562 in the year placed in service.
The mid-month convention applies to the first year placed in service and the year disposed. You get half a month's depreciation for the in-service month and full months for each subsequent month of the year. A rental placed in service on March 17 gets depreciation for half of March plus all of April through December - 9.5 months out of 12, or 79.17 percent of the full annual amount. Tax software handles the convention automatically; doing it by hand requires the IRS Pub 946 mid-month tables (Tables A-6 for 27.5-year residential).
An improvement (new roof, HVAC replacement, kitchen remodel, addition) is capitalized to the basis of the building and depreciated separately. Each improvement gets its own 27.5-year schedule starting from the date placed in service. A repair (fixing a leak, repainting, replacing a broken window) is deducted in the year incurred on Schedule E line 14.
A cost segregation study is an engineering analysis that reclassifies portions of the building into shorter MACRS classes:
Bonus depreciation under IRC §168(k) further accelerates 5-, 7-, and 15-year property. As of TY 2026, the bonus rate is being phased down (60 percent in 2024, 40 percent in 2025, 20 percent in 2026, 0 percent in 2027 absent legislative change). A cost segregation study is most useful for properties acquired for $500,000 and up; for smaller rentals the study fees often exceed the additional first-year deduction.
One of the most-confused areas of rental tax is the dual function of "14 days" in IRC §280A. There are actually two separate tests that operate independently, and conflating them is the most common rental-tax mistake first-time landlords make.
Under IRC §280A(g), if you rent your dwelling unit (used as a residence) for fewer than 15 days during the year, two things happen at once:
The provision is informally called the Augusta Rule because of its association with homeowners renting near Augusta National Golf Club during the Masters tournament. Because Augusta has limited hotel capacity, homeowners rent their houses to attendees for the week of the tournament. Under §280A(g), the entire week's rental income (often $20,000 to $50,000 or more) is tax-free. Common modern uses: renting your home for Super Bowl week, the Indianapolis 500, college reunions, conferences in tight markets, weddings, film productions.
The OBBBA (PL 119-21) signed July 4, 2025 did not modify §280A(g). The 14-day exclusion remains intact for tax year 2026. There has been periodic legislative discussion of expanding the exclusion (some proposals to 30 days), but no enacted change as of April 2026.
This is the second 14-day rule and has nothing to do with the Augusta exclusion. Under §280A(d), if you use a dwelling unit personally for more than the greater of:
then the property is classified as a "residence" for the year, and rental loss deductions are limited to gross rental income. You still report the rental income and expenses on Schedule E, but the net cannot fall below zero. Excess expenses carry forward.
Example: a vacation home rented 100 days at fair market price and used personally for 25 days fails the test (25 personal days > greater of 14 or 10 days). The property is classified as a residence. If gross rents are $20,000 and rental-allocated expenses are $25,000, only $20,000 of expenses is deductible against the rental income; the remaining $5,000 carries forward.
Personal use under §280A(d)(2) includes days you, your family, or anyone with an ownership interest used the property; also days rented to family at less than fair market value, days rented under reciprocal swap arrangements, or days rented to anyone at less than fair market value. Days the property was vacant or available for rent but not occupied are NOT personal use days.
If you rent fewer than 15 days, the Augusta Rule applies and personal use is irrelevant for income inclusion. If you rent 15 days or more, the personal use test (Test 2) becomes the determining factor for whether the property is a "residence" with capped losses or a regular rental with full Schedule E treatment.
Rental activities are passive activities under IRC §469(c)(2), which means rental losses can generally only offset other passive activity income (other rental net income or income from passive partnerships and S corporations). They cannot offset W-2 wages, self-employment income, or portfolio income (interest, dividends, capital gains).
The result for most landlords is that rental losses are suspended in the year incurred and carried forward on Form 8582 until either the property generates passive income, the taxpayer generates other passive income, or the property is sold in a fully taxable transaction.
Congress recognized that the passive loss rules would be punitive for ordinary middle-income landlords with one or two rentals. IRC §469(i) carves out a special allowance: if you actively participate in a rental real estate activity, you may deduct up to $25,000 of rental losses against non-passive income (wages, business, portfolio).
The allowance phases out by 50 cents per dollar of modified AGI over $100,000 and is fully eliminated at $150,000 MAGI. The phase-out structure is identical for Single, Head of Household, and MFJ filers, which produces a marriage penalty: two single people each earning $90,000 each get a $25,000 allowance ($50,000 combined); a married couple jointly earning $180,000 gets a fully phased-out $0 allowance.
Active participation is a less stringent test than material participation. The IRS and Tax Court have generally accepted that:
are sufficient to establish active participation, even if you use a property manager for day-to-day operations. Material participation (a different test under §469(h)) is more stringent and typically requires 500+ hours per year, "substantially all" the work, or similar quantitative tests; it is the standard for the real estate professional rules.
Losses disallowed under §469 carry forward on Form 8582 indefinitely. They are released in three situations:
The suspended losses are a real tax asset; they do not expire. Track them carefully on Form 8582 each year and verify they carry forward in your tax software.
The strongest rental tax planning tool is real estate professional status. A taxpayer who qualifies escapes the passive activity classification entirely for rental real estate; rental losses become non-passive and can fully offset W-2 wages, business income, and any other ordinary income source without the $25,000 cap or MAGI phase-out.
Under IRC §469(c)(7)(B), a taxpayer qualifies as a real estate professional for the year if both:
Per §469(c)(7)(C), a real property trade or business is any of: real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage. Real estate agents and brokers, property developers, builders, and full-time landlords managing significant portfolios are the typical candidates.
Real estate professional status alone does not make rental losses non-passive. The taxpayer must also materially participate in each rental real estate activity (or elect to aggregate all rental real estate as a single activity under Reg. §1.469-9(g)). Material participation generally requires 500+ hours per year per activity, or one of six other tests. The aggregation election is critical for taxpayers with multiple rentals because reaching 500 hours per property is often impossible.
Either spouse on a joint return can independently qualify as a real estate professional. The non-qualifying spouse's W-2 wages do not count against the qualifying spouse's 50 percent personal services test. This makes real estate professional status an attractive strategy for one-earner households where one spouse manages a real estate portfolio while the other earns W-2 wages.
The IRS routinely audits real estate professional claims. The most common reason for losing the status is inadequate contemporaneous documentation. Required:
"Reasonable estimates" reconstructed at audit are routinely rejected. Tax Court cases on real estate professional status are extensive; the IRS typically wins when the taxpayer's documentation is weak and the taxpayer wins when documentation is strong.
For taxpayers who do not qualify as real estate professionals but want to use rental losses against W-2 wages, the short-term rental "loophole" is the most powerful alternative strategy. It is grounded in Treas. Reg. §1.469-1T(e)(3)(ii)(A).
Under the regulation, a property is excluded from the definition of "rental activity" if the average period of customer use is 7 days or fewer. The average is computed across all paid customer use periods in the year. A property rented 50 times in the year, with each guest staying an average of 5 days, satisfies the test. A property rented 12 times in the year, with each guest staying an average of 14 days, does not.
Satisfying the 7-day average alone is not enough. The taxpayer must also materially participate in the activity. Material participation tests under Reg. §1.469-5T include:
For most STR landlords, the practical path is the "substantially all of the work" test (you do most of the work yourself, even if your total hours are modest) or the 100+ hours and more than anyone else test (you do more than your cleaner, your handyman, your manager).
If both tests are satisfied, the activity is non-passive. Rental losses (depreciation, operating expenses) flow against W-2 wages without the $25,000 cap or MAGI phase-out. For a high-W-2-income taxpayer with a vacation rental, this can produce $30,000 to $100,000 of W-2 offset in a single year, especially if a cost segregation study is layered on top to accelerate depreciation.
The STR activity still goes on Schedule E unless substantial services are provided. The non-passive treatment is achieved by checking the "material participation" box on Schedule E and not flowing the loss to Form 8582. The IRS pays close attention to STR loophole claims, so accurate booking records (showing each stay's check-in and check-out dates) and material participation documentation are essential.
Under IRC §1411, a 3.8 percent additional tax applies to net investment income, including most rental income, when modified AGI exceeds the threshold. Rental income that qualifies as a non-passive trade or business in which the taxpayer materially participates is generally NIIT-exempt.
These thresholds are statutory under the Affordable Care Act and have NOT been adjusted for inflation since the tax was enacted in 2013. The fixed nature of the thresholds means more taxpayers cross them each year as wages rise.
NIIT = 3.8 percent × the LESSER of:
Example: MFJ taxpayer with $300,000 MAGI ($50,000 over the $250K threshold) and $20,000 of net rental income. NIIT base is the lesser of $20,000 (rental net) or $50,000 (excess) = $20,000. NIIT = 3.8 percent × $20,000 = $760.
Per Reg. §1.1411-5, NIIT does not apply to net income from a trade or business in which the taxpayer materially participates. Real estate professionals (with material participation in each rental or aggregation election) and short-term rental landlords (avg stay 7 days or less plus material participation) typically escape NIIT on the rental income. Passive landlords (most ordinary single-family rental owners) pay NIIT once they cross the MAGI threshold.
The most expensive surprise in rental tax planning is depreciation recapture at sale. The IRS does not allow you to take depreciation deductions during the holding period and then escape the income tax on the depreciation when the property is sold. Under IRC §1250, the depreciation taken (or allowable) is recaptured.
For residential rental property held more than one year and depreciated using straight-line MACRS (which is the only method permitted for residential since 1987), the depreciation recapture is "unrecaptured §1250 gain" rather than ordinary income recapture. Unrecaptured §1250 gain is taxed at a maximum federal rate of 25 percent. Any gain above the depreciation amount is taxed at long-term capital gains rates (0, 15, or 20 percent depending on income).
You bought a rental for $300,000 (with $60,000 land allocation) on January 1, 2020. Depreciable basis is $240,000. Annual depreciation is $240,000 / 27.5 = $8,727. After 6 years of holding (through end of 2025), accumulated depreciation is approximately $52,364, reducing your adjusted basis to about $247,636.
You sell on January 1, 2026 for $450,000. Total gain = $450,000 - $247,636 = $202,364.
The key insight: the entire $52,364 of depreciation deductions taken during the holding period is recaptured at sale. The actual tax savings during the holding period was $52,364 × (your marginal rate during those years), so if you were in the 32 percent bracket those 6 years, you saved approximately $52,364 × 32 percent = $16,756 in income tax. But you pay back up to $13,091 at sale (25 percent × $52,364). Net depreciation benefit: $16,756 - $13,091 = $3,665 plus the time value of the front-loaded deductions.
This is the trap that catches landlords who skip depreciation. Under Treas. Reg. §1.167(a)-10(a) and IRC §1250(b), depreciation is recaptured at sale on the amount allowed OR allowable, whichever is greater. If you should have taken $52,364 of depreciation over 6 years and you took zero, the IRS still treats $52,364 as recapturable at sale, even though you got no current-year tax benefit. You pay tax on phantom income.
If you discover you missed depreciation in prior years, the fix is Form 3115 (Application for Change in Accounting Method) requesting an automatic change to claim a §481(a) adjustment. The catch-up adjustment claims all the missed depreciation as a current-year deduction in the year you file the form, restoring the time value lost. Form 3115 is automatic for this kind of change (no IRS approval required), but the technical requirements are exacting; a CPA filing is recommended.
If you exchange rental property for another rental property (qualifying real property under post-TCJA §1031 rules - real property only, no personal property), the gain (and depreciation recapture) is deferred into the replacement property's basis. The deferred gain is recognized only when the replacement is sold in a fully taxable transaction. §1031 is the primary planning tool to defer the recapture/capital gains tax indefinitely; with the "§1031 until you die" strategy combined with the §1014 step-up at death, the entire deferred gain can be eliminated for heirs.
Maria, a software engineer in Austin, MFJ household income $190,000, buys a single-family rental in 2026 for $325,000. The county assessor's ratio shows 80 percent improvement / 20 percent land, so she allocates $65,000 to land and $260,000 to the building. Annual depreciation is $260,000 / 27.5 = $9,455.
The depreciation absorbs most of Maria's positive cash flow. Schedule E shows a $2,055 paper loss, but at $190,000 MFJ MAGI she is fully phased out of the $25,000 allowance. The loss carries forward on Form 8582. Maria did not get a current-year tax benefit, but she also did not pay tax on the $9,455 of depreciation - the loss is real, just suspended.
Maria holds the property for 8 years. Each year shows similar paper losses of $2,000 to $4,000 that suspend forward (with rents rising and mortgage interest declining as the loan amortizes, the loss eventually flips to a small profit around year 6 or 7). When she sells in year 8 for $440,000, the suspended losses (totaling about $12,000 across the early years) are released against the sale gain. Plus the depreciation taken during 8 years (approximately $75,640) is recaptured at maximum 25 percent. The dollar math works out: she earned positive cash flow the entire holding period, deferred about $19,000 of federal tax to sale year via depreciation, and pays approximately $19,000 of recapture tax at sale (25 percent of $75,640). The net benefit was the time value plus the released suspended losses.
LMN Tax Inc. - Practitioner Insight
The most expensive rental-tax mistake we see at LMN Tax Inc. is the "I will skip depreciation this year" decision by new landlords. The reasoning is usually some version of "I do not need the deduction now and I will avoid recapture later." Both halves are wrong. The current-year deduction is real money you do not get back. Recapture happens regardless of whether you claimed depreciation, under the allowed-or-allowable rule of IRC §1250(b) and Treas. Reg. §1.167(a)-10(a). Skipping depreciation is paying current-year tax to avoid no future tax. The fix when a client shows up after 3 to 5 years of self-prepared returns without depreciation: Form 3115 (Application for Change in Accounting Method) to file a §481(a) catch-up adjustment, which claims all the missed depreciation in the current year. We file these regularly. The second-most-expensive mistake is misallocating land and improvement at acquisition. A 50/50 land/building split on a property with an actual 80/20 assessor ratio costs the landlord 30 percent of their depreciable basis - $90,000 of foregone depreciation on a $300,000 property over 27.5 years. Pull the assessor's ratio at acquisition. If the ratio looks aggressive on land (which is rare but happens), get an appraisal that allocates separately. The IRS does not have a "correct" ratio published; the standard is reasonable and supportable. Document your reasoning at acquisition; the support is much harder to assemble years later if the IRS audits.
One of the most common audit issues for rental property owners is the distinction between repairs (immediately deductible) and improvements (capitalized and depreciated). The Treasury "tangible property regulations" finalized in 2014 (T.D. 9636) provide the framework, but the line is fact-specific.
An expenditure is capitalized as an improvement if it is a:
Under Reg. §1.263(a)-1(f), a taxpayer with an applicable financial statement (audited financials) can elect to deduct items costing less than $5,000 per invoice or item; without an applicable financial statement, the threshold is $2,500. Make the election on the return each year (annual election) by attaching a statement. This safe harbor lets a small landlord write off most repair-like and small-improvement-like items currently without analysis under the three tests.
Under Reg. §1.263(a)-3(i), recurring maintenance activities expected to be performed more than once during the building's class life can be deducted currently as repairs even if they are technically restorations. HVAC servicing, gutter cleaning, periodic painting of exterior trim, and similar activities qualify.
Next Step
If you are a first-year landlord, start by allocating your purchase price between land and building using your county tax assessor's ratio. Pull the closing settlement statement (HUD-1 or ALTA) and add closing costs allocable to the building (title insurance, recording fees, transfer taxes) to your depreciable basis. Pull the assessor's ratio at the time of placing the property in service so the support is fresh.
Use the Rental Income Tax Calculator to model your year-1 Schedule E. If the result shows a loss and your MAGI is in the phase-out range, plan for the suspended-loss carryforward on Form 8582. If MAGI is high enough to fully phase out the $25,000 allowance, evaluate whether the short-term rental loophole or real estate professional path is realistic for you.
If you have other self-employed income alongside rental, project total annual liability through the Quarterly Tax Calculator and Self-Employment Tax Calculator. Rental income itself is generally not subject to self-employment tax, but combined returns often need quarterly estimates to avoid underpayment penalties.
If you missed depreciation on prior-year returns, consult a CPA about Form 3115 (Application for Change in Accounting Method) to file a §481(a) catch-up adjustment in the current year. The catch-up restores all the missed depreciation as a current-year deduction; it is one of the highest-leverage corrections available in rental tax practice.