How is depreciation on a rental house calculated?

The building portion of a residential rental is depreciated straight-line over 27.5 years using the mid-month convention; land is not depreciable, so the purchase price is split first. Depreciation begins when the home is ready and available to rent. Basis is reduced by allowable depreciation even if you never claimed it.

Can rental losses offset my W-2 income?

If you actively participate, up to $25,000 of rental losses a year can offset other income. The allowance phases out by 50 cents per dollar of MAGI above $100,000 and is gone at $150,000. Unused losses carry forward and are released when you sell the property to an unrelated buyer.

How are Airbnb short-term rentals taxed differently?

If the average stay is 7 days or less, it is not a rental activity under the passive rules, so the $25,000 allowance doesn't apply; losses depend on material participation. Hotel-like services can move reporting to Schedule C with self-employment tax. North Carolina taxes accommodation rentals under 90 days.

What tax do I pay when I sell a rental property?

The portion of the gain from depreciation is unrecaptured §1250 gain, taxed at up to 25%. The rest is taxed at long-term capital gain rates, and the 3.8% net investment income tax may apply. Suspended passive losses are released in the year of a full sale to an unrelated party.

Are there special North Carolina rules for rentals?

North Carolina adds back 85% of federal bonus depreciation and lets you deduct 20% of that add-back in each of the next five years. County property tax is due September 1 and payable without interest before January 6. Out-of-state owners report North Carolina-source rent on a nonresident return.

Rental Property Taxes: Schedule E and Passive Losses

The short answer

Rental income and expenses for a U.S. property go on Schedule E (Form 1040), and the building (not the land) is depreciated straight-line over 27.5 years. Rental losses are generally passive, but an owner who actively participates can use up to $25,000 a year against other income; that allowance phases out between $100,000 and $150,000 of modified adjusted gross income (MAGI). When you sell, the depreciation you took is taxed as unrecaptured §1250 gain at up to 25%, and in North Carolina the county property tax bill keeps coming either way.

Who this applies to

Families who moved and kept the old house as a rental, for example after buying a new home in Cary or Morrisville.

RTP tech employees and dual-income households buying investment property, who often land in the $100,000 to $150,000 phase-out range.

Airbnb and short-term rental hosts, where an average stay of 7 days or less changes the rules.

Owners living in another state or back in China who keep a North Carolina rental, since North Carolina-source rent still goes on a North Carolina return.

Small business owners renting their own building to their own company, where related-party rules need a case-by-case look.

Schedule E, depreciation and repairs

Rent minus mortgage interest, property tax, insurance, management fees, repairs and depreciation is reported on Schedule E.

Depreciation: residential rental buildings use GDS with a 27.5-year recovery period and the mid-month convention. Land is not depreciable, so the purchase price must be split between land and building. Depreciation starts when the property is placed in service, meaning ready and available to rent.

Unclaimed depreciation still counts: your basis is reduced by depreciation "allowed or allowable." Skipping depreciation does not avoid recapture later; it only gives up the deduction.

Repair or improvement: repairs such as fixing a leak, patching flooring or repainting are deductible. Improvements must be capitalized and depreciated. The IRS groups them as betterments (including fixing a defect that existed when you bought the property, or enlarging it), restorations (such as replacing a major structural component) and adaptations to a new use.

Safe harbors: with the de minimis safe harbor election you need not capitalize small purchases, and a routine maintenance safe harbor also exists. Check the IRS tangible property guidance for the limits and conditions.

The 2025 law: P.L. 119-21 restored 100% bonus depreciation for qualified property acquired and placed in service after January 19, 2025, such as appliances and furniture in a rental. The 27.5-year building itself does not qualify. North Carolina does not follow federal bonus depreciation: you add back 85% of it on the state return, then deduct 20% of the add-back in each of the next five tax years.

Passive losses and the $25,000 allowance

Rental losses generally offset only passive income, with a special allowance of up to $25,000 for owners who actively participate.

Active participation: you or your spouse make management decisions in a significant way, such as approving tenants, setting rent and approving repairs. You need at least a 10% ownership interest.

Phase-out: with MAGI of $100,000 or less, the full $25,000 is available. Above $100,000, the allowance shrinks by 50 cents per dollar, reaching zero at $150,000. Married filing separately and living apart all year: $12,500, phasing out between $50,000 and $75,000.

Unused losses carry forward on Form 8582. They offset future passive income, or are released in full when you sell your entire interest to an unrelated buyer.

Real estate professionals who also materially participate can escape the passive limits, but the test is demanding and requires time records.

Short-term rentals (average stay of 7 days or less)

If the average guest stay is 7 days or less, the activity is not a "rental activity" under the passive rules, so the $25,000 allowance does not apply.

Average stay: total rental days divided by the number of rentals during the year.

Losses: whether they offset other income depends on whether you materially participate. If you do not, they remain passive.

Substantial services: if you provide hotel-like services mainly for the guest's convenience, such as regular cleaning or changing linens, report on Schedule C, and self-employment tax may apply.

North Carolina sales and occupancy tax: rentals of accommodations for fewer than 90 continuous days are subject to sales tax, plus local room occupancy taxes. A private residence rented fewer than 15 days a year is exempt, but not when the rental is made through an accommodation facilitator such as a booking platform. Platforms generally collect, but hosts should verify.

Vacation homes you also use: personal use of more than the greater of 14 days or 10% of rental days means the home is "used as a home," which limits deductions. A home rented fewer than 15 days a year: the rent is not reported and the rental expenses are not deducted.

Selling a rental: depreciation recapture and NC property tax

The part of the gain due to depreciation is unrecaptured §1250 gain, taxed at up to 25%; the rest is taxed at long-term capital gain rates.

The math: gain equals the sale price minus selling costs, minus adjusted basis (cost plus improvements minus depreciation allowed or allowable). The sale is reported on Form 4797 and flows to Schedule D.

Suspended losses: a full sale to an unrelated party releases all suspended passive losses that year.

Net investment income tax: rental income and gain may also face the 3.8% NIIT (Form 8960).

A former home: the home sale exclusion ($250,000 / $500,000) may partly apply, but not to depreciation, and periods of nonqualified use reduce it. Run the numbers first.

North Carolina property tax: renting doesn't change the obligation. Under G.S. 105-360, county property taxes are due September 1 and payable without interest before January 6. Property tax on a rental is deductible on Schedule E.

A simple example

Simplified, with round numbers and state tax ignored.

Mr. Liu buys a rental in January 2026 for $400,000: $80,000 land and $320,000 building. Annual depreciation is about $320,000 ÷ 27.5 ≈ $11,636 (a little less in year one under the mid-month convention).

Rent is $30,000 and interest, property tax, insurance and repairs total $19,500, so after depreciation he has a loss of about $1,136. His MAGI is $120,000, so his allowance is $25,000 − ($120,000 − $100,000) × 50% = $15,000, and the whole loss offsets his wages. At $160,000 of MAGI it would carry forward instead.

Ten years later he sells for $550,000 with $30,000 of selling costs, after about $116,000 of depreciation. Adjusted basis is about $284,000 and gain about $236,000. About $116,000 is unrecaptured §1250 gain taxed at up to 25%; the remaining $120,000 or so is taxed at long-term capital gain rates, and any suspended losses are released.

Common mistakes

"If I don't claim depreciation, there's nothing to recapture." Basis drops by allowable depreciation anyway.

"A new roof or kitchen remodel is deductible this year." Most are improvements that must be depreciated.

"My Airbnb loss qualifies for the $25,000 allowance." Not if the average stay is 7 days or less.

"High income means my rental losses are lost." They carry forward and are released on sale.

"North Carolina depreciation matches federal." North Carolina adds back 85% of bonus depreciation.

What to do and when

In the year you buy or convert: keep the closing disclosure, split land and building, and record the placed-in-service date.

All year: keep rent records and receipts separately, and sort repairs from improvements. Short-term hosts should log each stay's length and the services they provide.

By December 31, 2026: estimate 2026 MAGI against the $100,000 to $150,000 range and decide on the de minimis safe harbor election.

January 5, 2027: last day to pay the 2026 North Carolina property tax bill without interest (due September 1; interest starts January 6).

April 15, 2027: 2026 Form 1040 with Schedule E, Form 4562 and Form 8582, plus North Carolina D-400.

How YCL can help

We prepare Schedule E, depreciation schedules (Form 4562) and passive loss carryforwards (Form 8582), along with North Carolina's bonus depreciation add-back and nonresident North Carolina returns for out-of-state owners.

For short-term hosts we review the 7-day rule, material participation and Schedule C treatment, and check platform-collected sales tax. Before a sale, we project recapture, capital gains and NIIT. See Real estate tax.

For the full process, see our guide: Rental property taxes.

YCL Accounting & Consulting is a multi-state CPA firm serving clients across the U.S. in English and Chinese, led by co-founder Gloria (Chenchen) Liu, CPA. You can start with a free 15-minute consultation.