Federal Rental Income Reporting

All rental income gets reported on Schedule E. You list gross rents, subtract deductible expenses, and the net figure flows to your 1040. Deductible expenses include mortgage interest, property taxes, insurance, repairs, property management fees, and depreciation. Residential rental buildings are depreciated over 27.5 years under IRC Section 168 using straight-line, which on a $900,000 building (excluding land) gives you about $32,727 per year in non-cash deductions.

That depreciation deduction is the engine of real estate tax planning. It often pushes your taxable rental income to zero or creates a paper loss, even when the property generates positive cash flow. But depreciation is recaptured at 25% under IRC Section 1250 when you sell, so think of it as a deferral rather than a permanent tax break.

California’s 13.3% Rate on Rental Income

California taxes rental income as ordinary income through the Franchise Tax Board. There’s no special rate, no passive income carve-out, and no distinction based on holding period. Your net rental income gets added to your salary, business income, and everything else, and you pay tax at your marginal rate. For income above $1 million, that rate includes the 1% Mental Health Services Act surcharge, pushing the effective top rate to 13.3%.

At more common income levels, the pain is still real. A landlord earning $120,000 in W-2 income plus $50,000 in net rental income faces a California marginal rate around 9.3% on that rental income. Combined with the federal rate (22% to 32% depending on bracket), you’re giving up 31% to 41% of your net rental income in taxes before you even think about property tax and insurance.

California conforms to federal passive activity rules under IRC Section 469, so the $25,000 rental loss allowance applies on your state return if your AGI is under $100,000. The phase-out works the same way: $1 of allowance lost for every $2 of AGI above $100,000, fully phased out at $150,000.

Proposition 13 and Property Taxes

Prop 13, passed in 1978, caps property tax assessments at 1% of the purchase price, with annual increases limited to 2% regardless of how much the property appreciates. For landlords who bought in the 1990s or early 2000s, this is a significant advantage. A building purchased for $400,000 in 1998 has an assessed value that’s a fraction of its current market value, even with the 2% annual increases compounding over 25+ years.

The catch: when you sell and someone else buys, the property gets reassessed at the new purchase price. This “Prop 13 trap” is one reason some LA landlords hold properties for decades even when the buildings are underperforming. Selling triggers a reassessment that can double or triple the buyer’s property tax bill compared to what the previous owner was paying.

For tax purposes, the low Prop 13 assessment means your property tax deduction on Schedule E is smaller than it would be in a state with market-value assessments. That’s a disadvantage on the deduction side, but the cash flow benefit of lower property tax bills more than makes up for it.

LA’s Rent Stabilization Ordinance (RSO)

The Los Angeles Rent Stabilization Ordinance covers apartments in buildings with two or more units built before October 1, 1978. Annual rent increases are tied to CPI and capped by the city — in recent years, allowable increases have ranged from 3% to 6%. Landlords must also pay an annual registration fee per unit to the LA Housing Department.

RSO creates a gap between market rent and what you can actually charge. A unit with a long-term tenant paying $1,400 when comparable market-rate units go for $2,200 represents $800 per month in lost revenue — $9,600 per year that you can’t recover through rent increases. On the tax side, you’re taxed on what you actually collect, not what the unit could theoretically earn. But lower revenue means lower net income, which means less cash to cover rising maintenance costs, insurance premiums, and seismic retrofit requirements.

The AB 1482 (California Tenant Protection Act of 2019) extended rent control statewide, capping annual increases at 5% plus CPI for buildings more than 15 years old. This overlaps with the city RSO and adds another layer of regulation for landlords who thought they were outside the city ordinance.

Selling Rental Property in Los Angeles

When you sell, you owe federal capital gains tax, depreciation recapture at 25% under IRC Section 1250, California income tax on the gain (at full ordinary rates, up to 13.3%), and Los Angeles documentary transfer tax at $4.50 per $1,000 of sale price (or $5.60 per $1,000 for properties over $5 million under the city’s Measure ULA, which took effect in 2023).

Measure ULA is the one that changed the math on larger sales. Properties selling for more than $5 million face a 4% transfer tax; sales above $10 million face 5.5%. On a $12 million apartment building, that’s a $660,000 transfer tax on top of federal and state capital gains. Some landlords have timed their sales to stay below the thresholds, and others have restructured ownership to avoid triggering a change-of-ownership reassessment.

A 1031 exchange under IRC Section 1031 defers federal and California capital gains tax if you reinvest in like-kind property. California conforms to federal 1031 rules, but the FTB tracks the deferred gain — if you exchange into out-of-state property, California still wants its share when you eventually sell. They call it a “clawback” and they enforce it.

Short-Term Rentals and Airbnb in LA

Los Angeles requires short-term rental hosts to register with the city and limits rentals to your primary residence for a maximum of 120 days per year (unless you get an extended license). The city collects a 14% Transient Occupancy Tax on short-term stays, which you’re responsible for remitting. Airbnb collects and remits this tax on your behalf for bookings made through their platform, but if you use other channels, you collect it yourself.

Short-term rental income is reported on Schedule E (or Schedule C if you provide substantial services to guests). The same California income tax rates apply, and you’ll owe self-employment tax if the activity qualifies as a business on Schedule C. The higher revenue per night compared to long-term rentals looks attractive, but between the TOT, income tax, and operating costs, the net margins can be thinner than they appear.

Sources

• IRS Schedule E — Supplemental Income and Loss
• 26 U.S.C. § 168 — Accelerated Cost Recovery (Depreciation)
• 26 U.S.C. § 469 — Passive Activity Losses
• 26 U.S.C. § 1250 — Gain From Dispositions of Depreciable Realty
• 26 U.S.C. § 1031 — Like-Kind Exchanges
• California BOE — Proposition 13 Background
• California FTB — Personal Income Tax Rates
• LA Housing Department — Rent Stabilization Ordinance
• AB 1482 — California Tenant Protection Act of 2019