Owning a rental property with one or more co-owners is a common scenario, especially among family members, friends, or business partners. When rental income is earned, it must be properly divided among the co-owners for accurate tax reporting and compliance with IRS rules. Improper reporting can lead to tax notices, audits, or even penalties. In this detailed blog, we’ll explain how to split rental income between co-owners, the IRS requirements, common pitfalls to avoid, and the documentation needed to support your tax filings.
Understanding Co-Ownership in Rental Properties
Rental property co-ownership typically takes one of the following legal forms:
- Joint Tenancy: Each co-owner has an equal and undivided interest in the property.
- Tenancy in Common: Each co-owner owns a specific share, which can be unequal.
- Partnership or LLC: The property is owned by a legal entity, and profits/losses are passed through to owners per the agreement.
How the income and expenses are split for tax purposes often depends on the ownership structure and any legal agreements in place.
Basic Rule: Proportional Allocation by Ownership Interest
The IRS generally requires rental income and expenses to be reported based on each co-owner’s share of ownership. For example, if two individuals each own 50% of a rental property, they must each report 50% of the income and 50% of the deductible expenses on their respective tax returns.
This rule applies whether the co-owners are related or unrelated, and regardless of how the income is actually received or deposited. Each person is responsible for reporting their share, even if they did not personally receive the payment.
Filing on Schedule E for Individual Co-Owners
When a rental property is co-owned by individuals who are not operating as a formal partnership, each person should file their share of the income and expenses on their own Schedule E (Form 1040).
On Schedule E:
- Each co-owner lists the property with their name and the property address.
- They report only their share of gross income, expenses, and depreciation.
- If one owner owns 40% and the other 60%, each reports only their proportional share.
Example Scenario
Suppose Sarah and James jointly own a rental property. Sarah owns 60%, and James owns 40%. The property generates $30,000 in annual rental income and $12,000 in expenses. Here’s how they would split it:
- Sarah (60%): Reports $18,000 income and $7,200 expenses
- James (40%): Reports $12,000 income and $4,800 expenses
Handling Unequal Contributions or Arrangements
In some cases, one co-owner may contribute more capital, manage the property, or handle all maintenance. If the co-owners agree to a different split of profits and losses, it must be documented legally—usually through a written partnership agreement or operating agreement if using an LLC.
The IRS may question unusual splits if they’re not properly documented. In general:
- Without a written agreement, the default is to split income and expenses according to ownership percentage.
- If the co-owners file a partnership return (Form 1065), income and expenses can be split per the partnership agreement.
- LLC owners use Schedule K-1 from the partnership return to report their share.
Using a Partnership or LLC for Co-Ownership
If you and your co-owners actively manage the property together and intend to operate it as a business, the IRS may classify the arrangement as a partnership. In that case:
- You must file a Form 1065, U.S. Return of Partnership Income.
- Each partner receives a Schedule K-1 showing their share of income and deductions.
- The K-1 amounts are then reported on each partner’s personal tax return.
Forming an LLC also provides liability protection and flexibility in structuring the income split. However, it comes with added filing requirements and costs.
Depreciation and Basis Considerations
Each co-owner must calculate depreciation based on their own adjusted basis in the property. This means:
- The purchase price is divided according to ownership share.
- The land value (non-depreciable) must be subtracted before calculating depreciation on the building.
- Improvements made by individual owners are depreciated only by the one who paid for them.
Properly allocating depreciation ensures that each owner claims the correct deduction and avoids overstatement of losses.
Co-Ownership With Spouses
If a rental property is jointly owned by spouses:
- And they file jointly — the full income and expenses are reported together on a single Schedule E.
- If they file separately — each must report half of the income and expenses (unless another ratio is documented).
In community property states (like California or Texas), both spouses may be considered equal owners, even if only one name is on the title.
Handling Expenses Paid by One Owner
If one co-owner pays all the expenses but does not own 100% of the property, they can only deduct their proportional share. The unpaid portion is considered a contribution to the other owner’s share and does not entitle them to a larger deduction.
To maintain clarity and avoid disputes:
- Use a joint bank account for property income and expenses.
- Maintain clear records showing expense allocations.
- Reimburse co-owners according to written agreements.
What If the Property Is Rented at a Loss?
Rental losses are subject to the IRS passive activity loss rules. Generally:
- Each co-owner can deduct up to $25,000 of rental losses against other income if they actively participate and their AGI is below $100,000.
- The deduction phases out between $100,000 and $150,000 of AGI.
- Excess losses are carried forward until the property produces income or is sold.
Key Documentation You Should Maintain
Good documentation is essential to support your allocations and avoid IRS scrutiny. Be sure to keep:
- A deed or title showing ownership percentages
- Operating agreement or partnership agreement (if applicable)
- Expense receipts and invoices
- Bank records of rental deposits and payments
- Depreciation schedules
- Correspondence between co-owners confirming allocation agreements
Common Mistakes to Avoid
- Splitting income and expenses inconsistently with ownership
- Failing to file required partnership returns if operating as a business
- Not depreciating the property correctly or claiming full depreciation without basis support
- Claiming deductions for another co-owner’s expenses
- Improperly allocating improvements or capital expenditures
When to Seek Professional Help
Tax situations involving co-ownership can become complex, especially with unequal ownership, improvements, or special arrangements. A qualified CPA or tax advisor can help you:
- Structure ownership and profit-sharing properly
- Prepare depreciation schedules
- Ensure proper filing on Schedule E, Form 1065, or K-1s
- Avoid audit triggers and IRS penalties
Final Thoughts
Splitting rental income between co-owners is more than just dividing checks—it involves accurate tax reporting, consistent accounting, and documentation to support your claims. Whether you’re casually sharing a vacation rental with family or running a multi-property portfolio through a partnership, understanding the rules and structuring your ownership appropriately ensures tax compliance and financial clarity. With the right approach and attention to detail, co-ownership can be both profitable and manageable.
