Investing in real estate is a popular way to diversify your portfolio, turn a hobby into a financial gain or even create a new primary stream of income. From active investments like rental property management, to passive investments like real estate investment trusts (REITs), there are many ways to enter this investment arena. As with any investment strategy, investing in real estate comes with inherent risk, but there are also many ways it can benefit your tax situation.
Tax Deductions
Depreciation
When you own a rental property, use it to produce income, and the property you own has a definable “useful life” of more than one year, you can typically deduct rental property depreciation on your taxes. Rental property depreciation is the process by which you deduct the cost of buying and/or improving real property that you rent. Depreciation spreads those costs across the property’s useful life.
Deductible Rental Property Expenses
Deductible rental expenses may include expenses related to your rental income, like property management, cleaning and maintenance, insurance premiums, utilities and more.
These deductions could include:
Costs of getting your property ready to rent
Paid advertising to attract tenants
Maintenance performed by others
Supplies and materials
Insurance payments
Property Management
Sometimes owning rental property can lead to the assistance of professionals like attorneys or property managers. The fees that are paid to individuals or companies you used to manage your property may be deductible. Note: be mindful that if these fees were already deducted from your portion of the rental income then you can not deduct it again.
If you manage your own rental property, you’ll usually report your rental income and expenses as part of your tax return (Schedule E). However, there are qualified deductions that you can subtract to lower your rental income to help lower your tax cost. To get more details, check out our article on property management tax deductions.
Improvements and repairs
Rental property improvements and repairs are both deductible, but the deductions must generally be done in two different ways. In general, improvements, like additions to a structure, need to be capitalized and depreciated over several years according to IRS depreciation tables. While repairs, like painting and fixing leaks, can be deducted in the year you pay for them. There is an exception to the rule on how you deduct improvements to your rental property like carpet, drapes, and appliances. If you are using your rental property as a business to make money, you may be able to deduct your rental property improvements the year you make them under the Section 179 deduction provision.
Capital Gains
A capital gain is the profit you receive when you sell a capital asset, which is property such as stocks, bonds, mutual fund shares and real estate. When you’re selling an asset you have held for one year or less it is considered a short-term capital gain. Short-term gains are typically taxed at ordinary income tax rates, from 10% to 37% in 2024. On the other hand, gains from the sale of an asset you have held for longer than a year is considered long-term capital gain. Long-term gains are typically taxed at a lower percentage, 0%, 15% or 20%, depending on your income.
Capital gains and REITs
Regarding real estate, capital gains can work in your favor in two different ways. With real estate investment trusts (REITs), investors report capital gains distributions as long-term, regardless of how long ago their investment was made. This means you will be paying less tax, even if your gains are from one year ago or less. Read more about tax tips for REITs.
Offsetting personal losses
As an investor, you can also offset any capital losses with capital gains. If you have an overall net capital loss for the year, you can deduct up to $3,000 of that loss against other kinds of income, including your salary and interest income. Any excess net capital loss can be carried over to subsequent years to be deducted against capital gains and against up to $3,000 of other kinds of income. Read more about capital gains and losses.
FICA taxes
People who are self-employed are normally required to pay income taxes for the Federal Insurance Contributions Act (FICA). However, rental income is exempt from this rule, so rental property owners do not have to pay FICA taxes on money they receive from their rentals. Read more about FICA.
Two more important points before we wrap up. First, buying a home for personal use is not generally considered a real estate investment. To find out more about the tax deductions on your residence, check out our article on home ownership tax deductions.
Lastly, there are many rules and regulations around real estate investment taxes. Let a local tax expert matched to your unique situation get your taxes done 100% right with TurboTax Live Full Service. Backed by our Full Service Guarantee.
The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.
