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Rental property offers significant tax advantages. Landlords can deduct operating expenses, depreciate the structure, and potentially offset other income with rental losses. Understanding rental tax rules helps property owners maximize benefits and avoid costly mistakes.

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How Rental Income Is Taxed

All payments received from tenants:
  • Monthly rent
  • Security deposits kept (when forfeited)
  • Late fees
  • Pet fees
  • Lease cancellation payments
  • Advance rent (taxable when received)
  • Services received in lieu of rent (at fair market value)
  • Security deposits that will be returned
  • Reimbursements from tenants for utilities (if you pay then collect)
Most landlords use cash method: report income when received, deduct expenses when paid.Accrual method reports income when earned and expenses when incurred, regardless of payment timing.Cash method is simpler for most individual landlords.

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Deductible Expenses

Fully deductible in year paid:
  • Property management fees
  • Advertising for tenants
  • Leasing commissions
  • Legal and professional fees
  • Property taxes
  • Insurance premiums
  • HOA fees
  • Utilities (if landlord pays)
  • Pest control
  • Landscaping and snow removal
  • Cleaning between tenants
  • Supplies
Repairs (fully deductible):
  • Fixing leaks
  • Patching holes
  • Repainting
  • Replacing broken fixtures
  • Unclogging drains
  • Replacing hardware
Improvements (capitalized and depreciated):
  • New roof
  • HVAC replacement
  • Appliance upgrades
  • New flooring
  • Additions
  • Kitchen remodel
Repairs maintain current condition. Improvements add value or extend useful life.
Interest on loans used to purchase or improve rental property is fully deductible against rental income.No limit like primary residence. Deductible even if you don’t itemize.
Travel to manage rental property is deductible:
  • Mileage to property (67 cents per mile for 2024)
  • Parking and tolls
  • Travel to meet with contractors, property manager, or attorney
Keep mileage log documenting date, destination, purpose, and miles.
If you manage rentals from home, may qualify for home office deduction.Requires regular and exclusive use for rental management activities.Deduct percentage of home expenses (utilities, insurance, repairs) based on square footage used.

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Depreciation

Depreciation is a non-cash deduction that reduces taxable income without spending money.
IRS assumes buildings lose value over time. Landlords deduct this assumed loss annually, reducing taxable rental income.Residential rental property: 27.5-year recovery period Commercial property: 39-year recovery periodOnly the building depreciates, not land. Must allocate purchase price between land and structure.
Example:
  • Purchase price: $300,000
  • Land value: $60,000 (20%)
  • Building value: $240,000
  • Annual depreciation: $240,000 / 27.5 = $8,727
This $8,727 deduction reduces taxable income each year without any cash outlay.
Starts when property is placed in service (ready and available for rent), not when purchased.First-year depreciation is prorated based on month placed in service.Depreciation continues even if property is temporarily vacant.
Depreciation is required, not optional. Even if you don’t claim it, IRS calculates depreciation recapture on sale as if you had.Failing to claim depreciation costs you deductions now without avoiding taxes later.
Depreciation reduces basis. When you sell, you’ll owe depreciation recapture tax (25% rate) on all depreciation claimed or that should have been claimed.

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Cost Segregation

Cost segregation accelerates depreciation by identifying components that can be depreciated faster than 27.5 years.
Engineering study identifies property components qualifying for shorter depreciation periods:
  • 5-year property (appliances, carpeting, certain fixtures)
  • 7-year property (furniture, equipment)
  • 15-year property (land improvements, landscaping, parking lots)
Front-loads deductions to early years of ownership.
  • Larger deductions in early years
  • Improved cash flow
  • Time value of money (deductions now worth more than later)
  • May create losses to offset other income
Generally worthwhile for properties over $500,000. Cost of study ($5,000 - $15,000) must be justified by tax savings.Best for:
  • New purchases
  • Recent renovations
  • Properties with significant improvements
  • High-income owners who can use deductions
Qualified property identified through cost segregation may be eligible for bonus depreciation (60% in 2024, phasing down annually).Allows immediate deduction of significant portion rather than spreading over years.

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Passive Activity Rules

Rental income is generally considered passive, subject to special limitations.
Passive income: Earnings from activities where you don’t materially participate (most rental income).Active income: Wages, self-employment income, business income where you materially participate.Generally, passive losses can only offset passive income, not active income.
If you qualify as real estate professional, rental activities can be non-passive, allowing losses to offset wages and other income.Requirements:
  • More than 750 hours in real property trades or businesses
  • More than half of personal services in real property trades or businesses
  • Material participation in each rental activity (or elect to aggregate)
Difficult for those with full-time jobs outside real estate.
Active participants in rental activities can deduct up to $25,000 in losses against non-passive income.Requirements:
  • Own at least 10% of property
  • Actively participate (approve tenants, set rents, approve repairs)
Phase-out:
  • Begins at $100,000 modified AGI
  • Completely phased out at $150,000 modified AGI
Many middle-income landlords lose this benefit as income rises.
Passive losses exceeding allowable deductions are suspended and carried forward.Can be used:
  • Against future passive income
  • When you sell the property (all suspended losses released)
Track suspended losses carefully. They have significant value on eventual sale.

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Qualified Business Income Deduction

Section 199A allows 20% deduction on qualified business income, potentially including rental income.
Rentals may qualify if conducted as trade or business. IRS safe harbor requires:
  • 250+ hours of rental services annually
  • Separate books and records
  • Contemporaneous records of services performed
Or demonstrate rental rises to level of trade or business based on facts.
20% of qualified business income deductible, subject to limitations based on taxable income, W-2 wages, and property basis.Example: $50,000 net rental income x 20% = $10,000 deduction.Complex rules apply. Higher-income taxpayers face additional limitations.
  • Triple net leases (generally)
  • Rental to commonly-controlled business
  • Properties not rising to trade or business level

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Record Keeping

  • All income received (date, amount, source)
  • All expenses paid (date, amount, purpose, vendor)
  • Mileage logs
  • Receipts for expenses over $75
  • Bank and credit card statements
  • Lease agreements
  • Tenant correspondence
  • Improvement documentation
  • General records: 3-7 years after filing
  • Records establishing basis: Until property sold plus 3-7 years
  • Depreciation schedules: Until property sold plus 3-7 years
Keep purchase documents and improvement records for entire ownership period.
Best practice: Separate bank account for each property or all rental activities.
  • Simplifies record keeping
  • Clear audit trail
  • Easier tax preparation
  • Required if property in LLC
Poor record keeping is the most common landlord tax mistake. Without documentation, you may lose deductions during audit. Keep receipts for everything.

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Common Mistakes

Depreciation is required. Failing to claim it forfeits deductions without avoiding recapture taxes on sale.
IRS audits this frequently. Major expenses that add value or extend life must be capitalized and depreciated, not deducted immediately.
Easy to overlook: mileage, home office, professional fees, education related to rental business.
Improvements increase basis, reducing future capital gains. Without records, you’ll overpay taxes when you sell.
Deducting rental losses against wages when not allowed creates audit risk and penalties.

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Converting Primary Residence to Rental

  • Depreciation begins when placed in service as rental
  • Basis for depreciation is lower of: cost basis or fair market value at conversion
  • Primary residence exclusion rules affected
Can still claim exclusion if you sell within 3 years of moving out (must have lived there 2 of last 5 years).After 3 years, exclusion is lost. Entire gain is taxable plus depreciation recapture.Gain attributable to non-qualified use (rental periods after 2008) is not excludable even if tests are met.
  • Consider selling before 3-year window closes
  • Or commit to long-term rental and plan for 1031 exchange
  • Document fair market value at conversion date

Next: 1031 Exchanges

Deferring capital gains on investment property

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