These are the 6 top tax benefits of owning rental property

Renting out a property is a proven and effective way to start investing in real estate. But did you know that income from a real estate investment is treated differently than income from working a job? There are ways to reduce your tax liability on investment income that can strengthen your bottom line.

Here are 6 of the most useful tax benefits of owning and earning income from rental property.

1. Tax deductions for real estate investment

One of the biggest financial perks of investing in real estate is the deductions you’re able to take. You get to deduct expenses directly tied to owning, managing, and maintaining the property, such as:

• Property taxes
• Property insurance
• Mortgage interest
• Property management fees
• Cost to maintain and repair the building

You also can write off some of what you pay to run and support your real estate investment business. Qualified business expenses may include, but aren’t limited to:

• Advertising
• Office space
• Business equipment, including computers, stationery, and business cards.
• Legal and accounting fees
• Travel

Be sure to keep detailed and accurate records and receipts for at least a few years so you can prove the expenses you claimed if you’re audited by the IRS.

2. Depreciation costs over time

Depreciation is the incremental loss of an asset’s value resulting from the assumed wear and tear. As a real estate investor who holds income-producing rental property, you can deduct rental property depreciation as an expense on your taxes.

You’re allowed to take the depreciation deduction each year for the entire expected life of a property. This is currently set by the IRS as 27.5 years for residential properties and 39 years for commercial properties.

For instance, let’s say you own a rental home, and the value of the house itself (excluding the land it sits on) is $300,000. If you divide that value by the 27.5-year expected life of the dwelling, you can deduct $10,909 in depreciation each year.

Depreciation recapture

Once you sell the property, though, be prepared to pay the standard income tax rate on the depreciation you’ve claimed if the home sells for more than the amount you depreciated. This requirement is known as depreciation recapture. The rationale for this is that the taxpayer has benefited from lower taxes due to claiming depreciation. It is the IRS’s way of recouping the lost tax revenue from prior years. You can often avoid depreciation recapture if you pursue other tax strategies, like a 1031 exchange.

3. Use a pass-through deduction

A pass-through deduction allows you to deduct up to 20% of your qualified business income on your personal tax return. When you own rental property as a sole proprietor, via a real estate partnership, or through an LLC or S Corp (known as pass-through entities), the money you collect in rent is considered QBI.

For example, if you have an LLC that owns an apartment complex, you could receive $30,000 in rental income every year. By using a pass-through deduction, you can write off up to $6,000 on your personal return. This perk, along with other provisions in the Tax Cut and Jobs Act of 2017, is set to expire on Dec. 31, 2025.

4. Take advantage of capital gains

A capital gains tax may be assessed when you sell an asset, like a piece of property, for a profit. There are two types to be aware of: short-term and long-term. They each affect your tax situation in different ways.

Short-term capital gains

When you profit from selling an asset within a year of owning it, you realize a short-term capital gain. Since it’s taxed as ordinary income, a short-term capital gain can lift you into a higher tax bracket for the year, resulting in a larger personal tax burden. For example, if you earn $100,000 from your day job and sell an investment property for a $100,000 profit, your income essentially doubles for tax purposes.

Long-term capital gains

You see a long-term capital gain if you profit from the sale of an asset that you’ve held for a year or longer. This benefits you because long-term capital gains have a significantly lower tax rate than standard income. In fact, if your personal income combined with your profit from long-term capital gains is low enough, you may not have to pay the tax at all. Depending on your income and whether you are filing singly or jointly, your tax on long-term capital gains in 2025 is either 20%, 15%, or 0%.

5. Defer taxes with incentive programs

To incentivize economic investment, the U.S. tax code has programs that allow you to defer tax liability on real estate sales. Two of the most prominent are the 1031 exchange and opportunity zone investment.

1031 exchange

A 1031 exchange, sometimes known as a real estate exchange or like-kind exchange, allows you to defer paying capital gains tax on the sale of a business or investment property by reinvesting the proceeds in other properties, provided the new property is of equal or greater value than the one you sell. If you eventually sell the new property, you can employ the 1031 exchange again indefinitely. Once you do sell a property and pocket the profit, you ultimately have to pay the capital gains tax. There are several forms of the program available, depending on the timing of your purchase and sale transactions. Since the program can be complicated to navigate and take full advantage of, it’s wise to consult with a qualified tax professional or real estate lawyer.

Opportunity zones

Designated by the U.S. Department of Treasury, opportunity zones are low-income or disadvantaged tracts of land. The 2017 Tax Cuts and Jobs Act encourages investors to put their money into developing and economically stimulating these communities by offering tax breaks.

Alongside other real estate investors, you place your unrealized capital gains into a Qualified Opportunity Fund. Money from that fund is used to improve the selected area.

If you play by the rules of the program, you can enjoy the following tax advantages:

• Defer paying capital gains until 2026 or until you sell your stake in the fund.
• Grow your capital gains by 10% if you hold the fund for 5 years and 15% for 7 years.
• Avoid paying capital gains entirely if you remain invested in the fund for 10 years or more.

6. Be self-employed without the FICA tax

When you’re self-employed, you generally need to pay both the employer and employee portion of the FICA tax, which funds Social Security and Medicare. This means that you pay the entire 15.3% FICA tax on your earnings – a significant amount. However, the income you earn from a rental property is not considered earned income and is not subject to FICA tax, also known as the payroll tax.

FICA tax break example

Let’s say you own a freelance writing business that generates $50,000 in revenue. Since that money is considered earned income, you’re responsible for the entire 15.3% payroll tax, or $7,650. If you were an employee at the local newspaper, your employer would pay half of that tax. Let’s say you also own a small rental house that generates $12,000 in net annual revenue. You do not have to pay any payroll tax on that portion of your income.

The bottom line: Make your real estate tax breaks count

If you have extra money, investing it in real estate is one of the best ways to let that money work for you. It can generate monthly income as well as grow in value over time if invested wisely. All of this income is ultimately subject to tax. Still, there are several ways to reduce your tax liability from real estate income. These real estate tax benefits, including deductions for mortgage interest and property taxes, as well as pass-through deductions and 1031 exchanges, can significantly reduce your tax burden and thus enhance the investment's value.

Are you ready to take the next step in your journey of real estate investing? Start your mortgage application online and diversify your investment portfolio today.