If you have rental properties that are producing an income, that income will need to be reported to the IRS.  If you are wondering what happens if you don’t report rental income to the IRS, there would be significant consequences. 

We will explore the consequences of not reporting rental income to the IRS. However, the easiest solution to avoid major issues is to simply report your rental income. 

How Is Rental Income Taxed?

Rental income is taxed as ordinary income. With that, the amount you owe in taxes will depend on the marginal tax bracket that you fall into. 

However, there are legal ways to lower the tax burden of your rental income. You can do this by offsetting your real estate losses against your rental income. Start by tallying up the total income produced by the property. This will include rent and any other fees paid by the tenant. Importantly, this will not include any security deposits unless you withheld a security deposit when a tenant didn’t live up to their end of the lease. 

Once you have the total income produced by the property, you can subtract any losses. Allowable expense deductions could include the cost of maintaining the property, mortgage interest, insurance costs, HOA fees, property taxes, and other expenses associated with the property. Plus, you can include depreciation costs as an offsetting cost. You can learn more about offsetting costs in our full post

These legitimate expenses will lower the tax burden of your rental income. However, you’ll need to maintain careful documentation of these expenses. You’ll still need to report all of your rental income, but the offsetting costs will help to lower your tax burden. 

Related: Optimizing Tax Expenses – Why it is Critical to Learn

What happens if you don't report rental income?

If you don’t report rental income to the IRS, you’ll be committing tax fraud. 

Unfortunately, there is no way to sugarcoat this. If you are hiding income from the IRS, including rental income, you’ll be committing tax fraud. 

How can I avoid paying tax on rental income?

In most cases, you cannot avoid paying taxes on your rental income. However, there are some unique cases in which the IRS doesn’t expect you to report your rental income. 

Let’s say you are only renting out the property for less than 14 days each year. At that point, you will not have to report any income. In most cases, you won’t be renting out a property for less than 14 days each year. But if you fall into that category, you won’t have to worry about reporting this income as rental income to the IRS. 

How does the IRS catch unreported rental income?

You might be wondering how the IRS can catch unreported rental income. After all, how could they know what you’ve earned in rental income unless you report it? 

The IRS can find out about unreported rental income through tax audits. The goal of an IRS tax audit is to review and examine the financial information and accounts of an individual to confirm that income was reported correctly. An audit can be triggered through random selection, computer screening, and related taxpayers. Once you are selected for a tax audit, you will be contacted via mail to start the process of reviewing your records. 

At that point, the IRS will determine if you have any unreported rental income floating around. If that is the case, the IRS will demand payment. Plus, additional fees and penalties will be added to your tax bill. 

Can I be reported for not claiming rental income?

Yes, you can be reported for not claiming rental income. If you aren’t reporting your rental income, then the IRS will likely find out at some point. 

When the IRS determines that you haven’t been reporting your rental income correctly, you’ll be facing a big tax bill with cumbersome penalties attached. Unfortunately, these can be financially crushing penalties that could take some time to pay off. 

reporting rental income

Should you report rental income on taxes?

In the end, the best way to avoid any tax issues is to report any rental income to the IRS. You don’t want to deal with an arduous tax audit or pay penalties for your choices. Plus, you could get caught in a situation in which you cannot afford to pay the penalties right away and find yourself with tax debt. 

Beyond the need to report rental income for a clean tax record, there is another reason why you should report the rental income. If you are a real estate investor that is hoping to build your portfolio, chances are that you’ll need to apply for a loan at some point. When you apply for a loan for a future property, the lender will look at your taxes to verify your income. 

If you don’t report your rental income, then you cannot prove your higher income to a potential lender. With that, you might not be able to obtain the loan you are looking for. With that, you could end up hurting the growth of your real estate portfolio by attempting to save money through tax fraud. 

It is clear that committing tax fraud is a no-win situation. With that, you should absolutely report all of your rental income to the IRS. 

If you have questions on how to report your rental income, then speak to a tax professional about your unique situation. I recommend checking out The House Hacking Podcast episode with Amanda Han to learn more about taxes and real estate

The bottom line

If you don’t report rental income, the consequences can be severe. You will be facing penalties levied by the IRS that could add up to a major expense. Additionally, you will hurt your own chances of securing funding for future properties because lenders rely on your tax returns to verify your income. With a lower reported income, you might not qualify for the loan you were hoping for. 

As you continue to build your real estate portfolio, take advantage of our free guide to investing in real estate. With a clear guide, you’ll be able to start building your real estate portfolio today