I talk with a lot of newer real estate investors, and very few of them truly understand all the tax benefits of real estate investing.
I don’t blame them. I’ve largely ignored this aspect of the business myself.
While I love numbers, I really hate paperwork. And when I think of taxes, all I can envision is a mountain of forms and headaches.
So, for a long time, I avoided optimizing my investments for tax efficiency.
And I’m now realizing what a massive mistake that was.
Sure, I’ve benefited from the basic tax perks of real estate investing. Most of us do by default.
But now, I’m starting to understand the more advanced strategies and how truly powerful they can be.
My goal with this article is to walk you through the different tax benefits of real estate investing. By the end, you should have a solid understanding of these strategies and where you might be in your journey.
So let’s get started.
Obvious Tax Benefits of Real Estate Investing
The first two real estate investing tax benefits are likely ones you’re already aware of.
And they happen automatically.
There’s not much to grasp here but they’re worth mentioning as we progress to the more advanced and interesting stuff.
#1: Mortgage Interest Deduction
I absolutely love debt, especially long duration fixed rate debt!
Most real estate investors would agree because financing properties with a mortgage is a large part of our strategy.
And the government encourages it through the ability to deduct mortgage interest paid on loans used to acquire or improve rental properties.
Mortgage interest can often be one of the largest expenses for investors, and deducting this can considerably reduce your taxable income.
This deduction is especially useful in the early years of a loan, when most of your payments are going toward interest instead of principal.
That’s important to understand because, over time, this benefit will decrease. Knowing this might drive decision making later down the road.
For example, you may choose to refinance simply to reset your debt clock and increase the amount of your monthly payment that goes toward interest.
I’m literally doing this right now and will write about it in the coming weeks.
Want to be notified when I do? 👇🏼
#2: Property Tax & Insurance Deduction
Real estate investors can also deduct the property taxes paid on their rental properties, as well as the cost of insurance premiums for their rental properties.
Again, most of us know and understand this. But it’s worth noting because at the end of the day it definitely helps your tax liability on rental income.
That said, you obviously don’t want higher taxes or to pay more toward insurance than is necessary.
There’s no benefit to that.
But it is nice that these costs are deductible in the first place.
Intermediate Tax Benefits of Real Estate Investing
Now, let’s move on to some of the less obvious tax benefits.
These are the ones that take a bit more understanding and planning, but once you start to grasp them, they can have a significant impact on your bottom line. They require a little more effort, but the rewards are well worth it.
#3: Deducting Repairs and Maintenance
There’s a big difference between how repairs and general maintenance are treated from a tax perspective versus capital expenses.
Repairs are fully deductible in the year they’re incurred. So what counts as a repair?
Things like fixing a leaky roof, repairing a broken HVAC system, or painting the property are examples of repairs. You’re fixing something that already exists rather than replacing it with something brand new.
The moment you replace something entirely (like a roof, furnace, or kitchen), it becomes a capital expense (or “capex”).
Capex items are not fully deductible in the year they’re incurred. Instead, they need to be depreciated over several years.
#4: Depreciation Deduction
And this is where I generally start having conversations where newer investors’ understanding of real estate investing tax benefits kind of falls off a cliff.
They understand items #1 and #2. And they largely understand how maintenance and repairs are tax deductible.
But depreciation starts getting a bit murky.
It’s also one of the biggest advantages real estate investors have at their disposal.
The IRS allows investors to deduct the cost of the property over its useful life, which is typically 27.5 years for residential properties.
This means that, even as the property potentially appreciates in value, you can claim a tax deduction for the wear and tear on the building, effectively lowering your taxable income.
Let’s look at an example.
Say you purchased a rental property for $100,000. For the sake of simplicity, let’s assume the land value is $0 (land is not depreciable).
That means every year you can write off $3,636 ($100,000 / 27.5 years = $3,636) against your rental income.
Let’s take this a step further and say you’re rental property netted you $2,400 in cash flow before all expenses. But when we deduct your depreciation you actually show a loss of $1,236 on your taxes.
Do you see why real estate investing is so beneficial? Your $2,400 isn’t taxed, and you even get to carry the loss forward to the next year.
Pretty amazing, huh?!
The beauty of depreciation is that it can often turn a property that’s cash flow positive into a tax-neutral or even tax-negative position, meaning you’re paying little to no taxes on the income generated by the property.
The key here is that depreciation is a “non-cash” deduction.
In other words, it’s not money coming out of your pocket like mortgage interest, property taxes, or insurance.
It’s simply a tax deduction that reflects the natural aging of your property over time. And that’s a huge advantage—depreciation can make a well-performing property look even better on your tax return.
The drawback to depreciation is the 27.5 year timeline.
If your rents go up significantly and, instead netting $2,400 annually it’s more like $5,000 you now have taxable income.
Some people will say “so what” but it’s worth considering what else you can do to further optimize with more advanced real estate investing tax benefits.
Advanced Tax Benefits of Real Estate Investing
This is currently the section I find myself in with my real estate investing journey. In fact, in 2023 my rental portfolio generated $86,000 in net taxable income.
That may sound great, but it’s not at all ideal.
Luckily I’m starting to take action to remedy this with more sophisticated tax strategies.
And again, if you want to know why I want to reduce that income and what I’m doing to make it happen, be sure to get on my mailing list 👇🏼
#5: Cost Segregation and Bonus Depreciation
Cost segregation and bonus depreciation partially solve our 27.5 year depreciation timeline “issue”.
They are advanced strategies that allow real estate investors to significantly accelerate depreciation deductions and reduce taxable income in the early years of ownership.
Cost Segregation is a process that breaks down the components of a property into shorter-lived assets (e.g., appliances, flooring, fixtures) that can be depreciated over shorter periods, such as 5, 7, or 15 years instead of the standard 27.5 years.
By identifying components that can be depreciated more quickly, you can boost your depreciation deductions early on, which can have a big impact on your bottom line.
Hopefully that doesn’t make your head spin too much.
The idea here is that you’re able to pull some items out of the blanket 27.5 year timeframe and put them on a shorter depreciation schedule.
That means, instead of deducting $3,636 per year (from our earlier example) you can accelerate a good chunk of that depreciation deduction.
It may look something like this:
Remember, while you’re able to shorten the depreciation schedule on some items, many of them are still going to fall under a 27.5 year depreciation schedule.
For example I put a new roof on The Great Greydale this year. It cost me $10,000 and, while I’d love to take that cost of the current year’s income, it must be depreciated over 27.5 years.
A cost segregation study can really help cancel out net rental income much better than a standard depreciation schedule.
But wait, there’s more…
Bonus Depreciation allows investors to take even more depreciation upfront.
Under current tax law, you can take 60% of items that are depreciable in under 20 years.
This is huge!
Again, let’s go back to our example.
Instead of trying to walk through all the math and logic, I’ll simply show you what that might look like:
Note this is simply an illustrative example, but it is directionally correct.
I am not a tax advisor, CPA, or an expert in cost segregation studies. But this is something I’m heavily weighing on my own rental portfolio and considering before making future purchases.
When combined with cost segregation, bonus depreciation can significantly reduce your taxable income, especially in the first few years of owning a property.
I know this is a lot to digest, especially if this is your first time getting familiar with cost segregation and bonus depreciation. Trust me, it made my head spin initially too.
But the more you look at it, tinker, and talk to others about these strategies, the more second nature it becomes.
And they are powerful for investors who want to maximize cash flow and minimize their tax burden..
All that said, eventually, these wins come to roost. And you either have to pay the tax man or continue to defer.
#6: The 1031 Exchange
I think most investors are familiar with, or at least aware of, the 1031 exchange.
In short, it allows you to sell a property and buy another property without paying taxes or depreciation recapture.
I’m oversimplifying it quite a bit, but that’s the gist of it.
This is attractive to people because once you do finally sell a property you’re not only going to pay capital gains tax on the proceeds, but you’re also going to incur depreciation recapture.
What’s that mean?
It means all that depreciation you deducted ends up coming back.
Yep, it’s great in the moment but it doesn’t last forever… unless you do a 1031 exchange.
This allows you to essentially “keep the game going” and defer paying taxes or repaying depreciation.
Many people will do this indefinitely, leaving the property to their children upon their passing. Then, the heirs receive a step up cost basis.
In short, they never end up having to pay any taxes on the proceeds or the past depreciation.
A 1031 exchange also allows real estate investors to “trade up” to larger properties over time because they aren’t taking a tax hit when selling.
This isn’t something I’ve personally done yet, but it will definitely be a consideration before I plan on selling anything.
Real Estate Investing Tax Benefits Conclusion
Real estate taxes can be intimidating and, honestly, pretty boring. But once you start understanding all the benefits, it can feel like a game—and the benefits are enormous.
As I started understanding depreciation, cost segregation, bonus depreciation, etc. it all became far more exciting. I now better understand why real estate investing is such a powerful wealth building vehicle.
And I’m now on a mission to continue learning and utilizing all of these different tax benefits.
Hopefully this article inspires you to dig more into the topic of real estate investing tax benefits and do the same.