Tax Benefits of Rental Real Estate

Real estate can be a powerful tool for building wealth while offering unique tax advantages. From depreciation deductions to rental income offsets, investing in rental properties can help reduce your tax burden and improve cash flow. However, the rules around real estate taxation can be complex, with depreciation schedules, passive loss limitations, and financing strategies all playing a role. In this DrillBuit Series blog, we’ll explore the key tax benefits of rental real estate, helping you understand how to maximize deductions, leverage depreciation, and determine if real estate is the right investment for you.

The Bottom Line  

Real estate can be a tax-advantaged way to shelter income from taxes and build wealth.  

Can I write off the cost of the property? 

This is always the first question! The basic answer is Yes, but... 

• the cost of land is not deductible until you sell it, and 
• the cost of the building, furniture, equipment etc. must be spread over the life of the assets. 

The IRS regulations impose a 27.5 year life on residential buildings and 39 years for commercial buildings.  Land improvements like a parking lot have a 15 year life, equipment or furniture is usually 5 to 7 years.  There are some exceptions and opportunities for faster write-offs. 

The deduction of these costs over time is called depreciation. 

Is there a tax benefit if I have to depreciate assets over time? 

The secret is leverage or using Other People’s Money.  I can depreciate property purchased with debt, so I get depreciation deductions on Other People’s Money.  In some cases, depreciation may create an overall loss which may offset other income, subject to the passive loss restrictions (below). 

Rental Income 

Rents from tenants,  

     Less: cash expenses like advertising for tenants, maintenance, manager fees, HOA dues, property taxes, mortgage interest, etc 

          Less: depreciation of the asset costs, 

               Equals: net rental income or loss. 

Rental losses can offset other income such as W-2 wages, investment or business income IF you are not subject to the passive loss limitation rules. 

Passive Loss Limitation 

Rental losses on investment property are considered “passive losses” and are limited to $25,000 if modified adjusted gross income is $100,000 or less and phases out when MAGI hits $150,000. Unused losses carry forward to offset future passive income or they reduce gains upon sale of the property.  Rental losses are not subject to the limiation if the owner meets the “real estate professional” requirements. Generally if over 50% of your services are in real estate or you performed over 750 hours in real estate, you may qualify as a real estate professional.  Consult a tax expert! 

Is Real Estate a Good Investment? 

Many people have created wealth by properly managing real estate purchased at the right price, in the right location, with the right amount and type of debt.  Realize that appreciation is not always guaranteed and may fluctuate as the economy cycles.  Your accountant can help you estimate income or loss, equity buildup, return on investment and tax consequences of investments you may be considering. 

Understanding the tax benefits of rental real estate can help you make informed investment decisions and maximize your financial returns. Whether you’re looking to optimize deductions, leverage depreciation, or determine if real estate is the right investment for you, we’re here to help. Contact us for expert guidance on navigating real estate taxation and making the most of your investment opportunities.