Investing in real estate allows you to generate cash flow, build equity, and take advantage of home price appreciation.
In addition, the federal government offers a slew of lucrative tax benefits for rental property owners—including deductions and tax breaks for depreciation, mortgage interest, insurance, state and local taxes, repairs and maintenance, insurance, like-kind exchanges, and other situations.
The key, however, is knowing what tax benefits are available, how they work, and how to make the most of them. For instance, while some of these tax deductions can be claimed in the year you incur them, other tax benefits may take several years to play out entirely.
Though you should always refer to your CPA or tax attorney for tax advice, we hope this guide can serve as a quick primer to help you get started.
| Tax benefit | Also available to ordinary (non-investor) homeowners? | Relevant statutes | Further reading |
| Rental property depreciation | No. | IRC Section 167 and IRC Section 1250 | Publication 527 (Chapter 2) and IRS Depreciation & Recapture FAQs |
| Mortgage interest deduction | Yes, for principal balances of $750,000 or less. | IRC Section 163 | Publication 527 (Chapter 1) and Publication 936 |
| State and local property taxes | Yes, up to a total of $10,000. | IRC Section 461 and IRC Section 164 | Publication 530 and Publication 523 |
| Repairs and maintenance | No. | IRS Section 162 and IRS Section 263 | Publication 527 |
| Property insurance | No. | IRS Section 162 | IRS Tips |
| Other deductible operating expenses | No. | IRS Section 162 | Tax Topic No. 414 |
| Payroll taxes | Not applicable. | IRC Section 469 | Publication 925 |
| Qualified business income | Not applicable. | IRS Section 199A | Fact Sheet 2019-8 and Notice 2019-07 |
| Like-kind exchange | Not applicable. | IRC Section 1031 | Fact Sheet 2008-18 |
| Qualified Opportunity zones (QOZs) | Not applicable. | IRC Section 1400Z-2 | Tax Cuts and Jobs Act (TCJA) |
| Passive Activity Losses (PALs) | Yes, up to $25,000 for MAGI under $100,000 | IRC Section 469 | Publication 925 and Tax Topic No. 425 |
Deduct operating expenses
As a real estate investor, you can deduct all ordinary and necessary expenses from your gross rental income to lower your taxable income. Here’s a brief overview of the most common deductible expenses.
Rental property depreciation
Depreciation allows you to write off the wear and tear of your property over its useful life—usually 27.5 years for residential properties and 39 years for commercial real estate.
If you’re a regular homeowner, however, you’re out of luck—only real estate investors who use their rentals for a “business or income-producing activity” are eligible for this tax advantage.
That said, this tax benefit comes with a significant caveat: any gain realized on the sale of a rental property is subject to depreciation recapture. In essence, you’ll have to “pay back” the depreciation you claimed while you owned the property.
Mortgage interest deduction
As a real estate investor, you can deduct any interest paid on a loan secured by your property—without limitation. Late payment charges, closing costs, prepayment penalties, prepaid interest like mortgage discount points, and mortgage insurance are also deductible expenses.
State and local taxes
You’re also eligible to deduct state and local property, income, sales, fuel, franchise, and excise taxes from your federal income tax return. Though the IRS limits the deduction for ordinary homeowners to $10,000 per year (or $5,000 for married taxpayers filing separately), this deduction is unlimited for real estate investors.
Repairs and maintenance
You can fully deduct the cost of repairs and maintenance performed on your rental property in the year they were incurred. Note, however, that there’s an important difference between what the IRS classifies as a repair and what it calls an improvement.
Repairs are one-time fixes that keep your rental in good, habitable condition. They do not add any significant resale value to your investment property and are classified as operating expenses. For instance, fixing a broken window, unclogging a shower drain, or replacing a burnt-out lightbulb would be examples of repairs.
On the other hand, improvements such as installing solar panels, building a pool in the backyard, or expanding a garage either add value to your property or extend its useful life. These are capital expenditures that must be depreciated over the useful life of your property.
Property insurance
Rental property investors can deduct insurance premiums incurred as part of their rental activities as business expenses. This includes fire, theft, earthquake, liability, and flood insurance for their rental property, as well as comprehensive coverage.
Other deductible operating expenses
As a landlord, you may also encounter sales and marketing expenses, property management costs, home office expenses, fees for professional services (such as appraisal, legal, accounting, title, and broker fees), expenses related to travel to and from the property, and other operating costs.
Most or all of these expenses are typically deductible in the year you incur them—though check in with your accountant or tax advisor to be sure.
Avoid payroll taxes
The IRS classifies rental activity as passive income—even if you materially participate in the activity, This is good news, since you don’t owe payroll taxes on passive income.
While you get a free pass on Social Security and Medicare taxes, keep in mind that rental income is otherwise taxed as ordinary income—meaning that you won’t be able to take advantage of long-term capital gains rates.
Earn qualified business income
You can deduct up to 20% of your qualified business income (QBI) on your personal taxes if you own rental property via a pass-through business entity like a sole proprietorship, partnership, limited liability company (LLC), or S corporation.
Unlike C corporations, pass-through entities are not taxed at the corporate (i.e. entity) level. Instead, taxable income or losses are reported on an individual’s tax return. To claim a QBI deduction, your rental real estate business should collect rent, maintain detailed records, and provide a minimum of 250 hours of rental services per year.
Defer taxes using like-kind exchanges
Like-kind exchanges—commonly called Section 1031 exchanges—allow you to defer capital gains and depreciation recapture taxes by swapping your investment property for like-kind property of the same or greater value for tax purposes.
To conduct a 1031 exchange, you should first sell your current property. Then, the clock starts ticking—fast. You are required to identify (in writing) a replacement property within 45 days and purchase that same property within 180 days from the date you sold your original property. These deadlines are extremely strict, and extensions will not be granted. However, when executed correctly, you can perform 1031 exchanges indefinitely.
Invest in qualified opportunity zones
Designated by the U.S. Department of the Treasury and enacted as part of the Tax Cuts and Jobs Act (TCJA) of 2017, Opportunity Zones offer tax advantages to investors willing to put their money in specific rural and distressed urban areas.
You can invest in properties within Opportunity Zones through Qualified Opportunity Funds (QOFs) to enjoy preferential tax treatment on capital gains. By investing in QOFs, you can:
- Defer tax on capital gains until 2026 or until you sell your stake, whichever is earlier.
- Receive a 10% or 15% step-up basis if you hold the fund for at least 5 years or 7 years, respectively.
- Avoid paying capital gains entirely if you retain your investment in the fund for 10 or more years.
Claim passive activity losses (PALs)
Thanks to depreciation and other operating expenses deductions, your property may produce a net loss for tax purposes. Specifically, the IRS classifies losses from rental properties as passive losses. In such an event, you can offset up to $25,000 in passive losses against your W-2 income if your modified adjusted gross income (MAGI) is at or under $100,000.
The deduction allowance is reduced by $1 for every $2 your MAGI exceeds the $100,000 threshold by, and is therefore completely disallowed if your MAGI is $150,000 or higher.