If your rental income doesn't pay off the mortgage, that's bad news for you. Worse news: you can't write off the red ink on your taxes. Paying off the mortgage principal isn't a deductible expense -- all you can claim is the interest. If that makes your rental a cash drain instead of a cash cow, the IRS can't help.
There's a reason tax laws don't let you treat mortgage payments as all-deductible. When you take out the mortgage, no matter how big it is, the principal you pay back doesn't count as income to the lender, because you borrowed it, and the IRS assumes you'll pay it back. The interest you pay is income to the lender, however, on which the lender must pay income tax -- because the lender pays the income tax on this portion, you can deduct it from your own income.
Mortgage interest on your personal home is only deductible if you itemize on Schedule A. Mortgage interest on the rental, however, is completely deductible. If you live in the house part of the time, you have to compromise. If you only rent out the property 10 months of the year, say, you can only deduct a fraction of the mortgage interest: in this case, 10/12.
If you meet the IRS definition of a real-estate professional, you can write off rental expenses against non-rental income. Usually real estate has to be your main source of income, or you put in at least 750 hours during the year. If you're not a pro, you can still write off up to $25,000 in expenses if you actively manage the property, vetting tenants, contacting the plumber for repairs and so on. Otherwise you have to carry over any red ink to next year and subtract it from rental income then.
Even if the mortgage-principal payments push your rental into the red, the tax savings from writing off $25,000 in expenses may make up for it. If not, consider whether it's possible to increase the rent. Rent should reflect your expenses, but it's also limited by the market: if tenants can find somewhere just as good for less, upping the rent may not work. You may still have good reasons for keeping the house -- it's a favored vacation home, or you can't afford to sell in the current market, for instance.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.