One of the Biggest Financial Advantages of Owning Residential Rental Properties

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Of all the articles I’ve written about the amazing financial benefits of rental properties, I realize now that I’ve left out one of the biggest perks of owning a residential rental property. Someone in a recent comment on one of my articles mentioned it, and my jaw dropped thinking about how I’ve not spent a lot of time talking about this!

Are you ready?

Let me warm up your suspense a little bit. I’ve done quite a few articles and videos showing how to run cash flow calculations on a prospective rental property. For example, check out “Rental Properties So Easy You Can Calculate Them on a Napkin.”

A question that gets asked several times regarding my cash flow calculations is, “Where do you account for the taxes you have to pay on that income?”

Why do readers ask that question? Well, it’s because I don’t include it in the numbers. Why don’t I?

Are you ready for one of the biggest financial perks of owning residential rental properties as an investment?

You don’t have to pay taxes on income received from residential rental properties!


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A Few Caveats

Before I even go any further, I’m going to tell you right now that I am not a tax expert. Like with all investments or business things, I highly recommend you consult a professional in this field for exact and more accurate details. In the case of taxes, I highly recommend you work with an accountant who specializes in real estate investing. Trust me, not all of them do. If you own real estate investments, I think you are crazy if you don’t let a professional do your taxes. Tax benefits are one of the strongest perks of owning property, and I promise you that TurboTax or your local H&R Block are not suited for the challenge of maximizing your benefits for you.

Related: The Ultimate Guide to Real Estate Investment Tax Benefits

Another caveat to this claim is that yes, you end up not having to pay taxes on rental property income, but you don’t go about that by just not paying anything or filing anything. There are some things you have to do in order to make your income tax-free, and you have to do those things right. But it’s not hard, and if you work with a professional to make sure it’s done correctly, it’s easy peasy.

The Magic of Depreciation

I have yet to have ever paid any taxes on the income I get from my rental properties. Am I a sneaky felon con who wiggles my way around paying taxes? Absolutely not. Not paying taxes on rental property income is VERY legal! In fact, it gets even better than that. Not only have I never paid taxes on my rental property income, but I’ve also ended up claiming “losses” on them. That “loss” then gets put towards my other life income, so I actually end up profiting more money on top of just not having to pay taxes! Again, all very legal.

Ultimately, how this works is: The amount of deductions you are allowed to write-off on a rental property typically exceeds the amount you receive in rents. Therefore, if you (legally) write off as much or more than you made on the property, there’s nothing left to pay tax on!

But how do the write-offs possibly total more than what you bring in? I’ll give you one word — depreciation.

What Exactly is Depreciation?

Depreciation is a term used by the IRS to say that properties lose value over time. The condition of the property, for example, has to deteriorate with time. Even if your property is appreciating in value, the IRS still considers your property to be depreciating as well.

Residential rental properties are the only asset class that both go up in value and down in value, all at the same time!

The way the IRS handles depreciation is by letting you write off what they determine to be an appropriate amount for depreciation based on the value of the structure (not the land) of your property. I’m not going to go into extreme details on how this calculation works, but the basic idea is that you first determine the value of the property structure (subtract land value from the total value to end up with the value of the structure). You then divide that number by 27.5 because the IRS bases all of this off a 27.5 year straight-line schedule. Then the number you are left with, per year, you can write off as a “loss.”

An Example

For example, if the value of the structure of your property is worth $140,000, dividing that by 27.5 comes out to just over $5,000 per year. You get to write off $5,000 per year! They call this a “phantom loss” because you never actually lost the money. How great is that? Writing off money you never actually lost! Yes, please.

Related: Tax-Saving Strategies for Real Estate Investors: How to Pay Less & Keep More This Year

So, you would take this $5,000 per year (or whatever your number is) and then add to that mortgage interest (which can be a lot as well), operating expenses (property tax, insurance, repairs — not capital improvements), travel expenses, and property management fees and HOA fees if applicable. All of those things combined equate to what you are going to write off against the income the property brought in.

There is a very good chance that all of those expenses combined (including the phantom depreciation loss) equal more than you earned. If it equals how much you brought in, you pay no taxes. If it’s more than what you brought in, you can take that “loss” against your other forms of income! This could save you even more in taxes, or depending on your tax bracket and income levels, it might even knock you down into a lower tax bracket overall. So then you pay even less taxes.


Get a Good Accountant

As I said, for details on all of this, consult a professional accountant (preferably specializing in real estate investing). There are some contingencies on exactly how much can be taken from where, but those contingencies don’t negate the principle of how and why your income from residential rental properties typically ends up being tax-free.

I can tell you from personal experience, I never had higher tax returns than I did after I started buying rental properties. The difference in my returns pre and post-rental property ownership are like night and day.

There you have it. The mystery of the secret financial benefit to residential rental properties that your grandma probably never told you!

Oh, and one last mention. This information does NOT pertain to flipping properties. This is specific to rental properties because the IRS considers rental property income to be “passive income,” and passive income is the only place where all these little loopholes exist. Flipping income is considered “active” income and does not get the same perks.

Let’s have it, folks. I’m sure many of you are kingpins of taxes and can speak to all of this is grave detail!

Be sure to leave a comment below!

About Author

Ali Boone

Ali Boone is a lifestyle entrepreneur, business consultant, and real estate investor. Ali left her corporate job as an Aerospace Engineer to follow her passion for being her own boss and creating true lifestyle design. She did this through real estate investing, using primarily creative financing to purchase five properties in her first 18 months of investing. Ali’s real estate portfolio started with pre-construction investments in Nicaragua and then moved towards turnkey rental properties in various markets throughout the U.S. With this success, she went on to create her company Hipster Investments, which focuses on turnkey rental properties and offers hands-on support for new investors and those going through the investing process. She’s written nearly 200 articles for BiggerPockets and has been featured in Fox Business, The Motley Fool, and Personal Real Estate Investor Magazine. She still owns her first turnkey rental properties and is a co-owner and the landlord of property local to her in Venice Beach.


  1. Keith Schulz

    Yes, depreciation can help offset some of your income on rental property. However, you have to reclaim the depreciation when you sell unless you do a tax deferred (1031) exchange . So, unless you you exchange until you die, you will end up paying taxes and some point. This can be a huge hit to someone who is not planning on it. I’ve seen many investors make the mistake, not realizing they have a big tax bill when they sell. Also, if you pay 0 taxes on your rental because your mortgage interest and depreciation offset your income, you probably aren’t making much. I’m not trying to knock the author of this article. It’s well written and makes some great points. I just don’t want rookie investors to be misled.

    • Brandon Hall

      Plenty of other ways to defer taxes other than a 1031.

      “Also, if you pay 0 taxes on your rental because your mortgage interest and depreciation offset your income, you probably aren’t making much.”

      If you buy a $100k property with a $90k building value, your annual depreciation is $3,272. If your net rental income prior to deprecation/amortization (EBDA) is $3,272, then your depreciation is going to 100% offset your current year net income. On a $100k property, you probably put $30k into it, so that’s a pretty sweet return, no?

      And sure, you have to recapture it at some point, but that’s relatively a moot point. When contemplating the time value of money and IRR, I’d rather avoid taxes today and pay them later than pay taxes today and not have to pay them later.

      • John L.

        Hi there,

        Nice article! I was going to raise some of the same points as Keith.

        Could you elaborate on plenty of other ways to defer taxes other than a 1031? Also, I think I’d have to disagree that depreciation recapture is a moot point. You are returning a significant amount of the depreciation taken whenever the property is sold. I think that’s an important point for people who are new to real estate investing.

    • Lisa Weathers

      Keith, I agree with your comment about you’re probably not making much if your mortgage interest and depreciation offset your income. When I first started purchasing rental homes 12 years ago and had 30-year mortgages at a higher interest rate, then I did have enough expenses to have a loss. However, when I refinanced a few years ago to 15-year mortgages, I got quite a sticker shock at tax time the following year because I no longer had all that mortgage interest to deduct. I felt a little better when I read a statement online that said, ‘You will never pay more in taxes than you will in mortgage interest.’ When I figured up how much I was saving each year in mortgage interest by going to 15-year mortgages at a lesser interest rate over what I was paying in taxes, I realized they were correct. Really the only semi-free expense you get to deduct is depreciation, everything else you’re simply paying to someone else other than the government.

      • Ali Boone

        Lisa. All valid. A lot of it will depend on your goals and how you want to structure it. It’s a balance of….is it better to have my tenants cover the mortgage (interest) expense or compare it to what I get in taxes. And the numbers on the property are critical because if the property won’t cash flow with all the expenses, then considerations have to be made. All your points are worth playing with and deciding on.

    • Ali Boone

      No knocking at all, Keith. I always welcome all points and info, and I’m definitely not a complete expert on anything so I always welcome the help!

      I will say that most investors I know will always continue to roll with the 1031 to avoid the taxes, so it’s definitely doable. And at least on my rental properties I make great cash flow while still offsetting my taxes. I have so far always profited on my taxes rather than paying anything. Whether some cash flows or not will be very dependent on how they bought….numbers are key!

      But all excellent, and valid considerations to make sure are thinking about.

  2. Huiping Sheng

    Thanks Ali!
    Two questions want to get a help from you:

    1)I brought a home already 15 years old, do I have 27.5 years deprecation or only 27.5-15=12.5 years?
    2) If I have rental property income but it is not enough for me to write-off all I can write-off related to rental property, can I write-off those extra cost from my W-2 income?

    Thanks again.

    • Ali Boone

      Hi Huiping! I want to be very careful in saying yes or no to anything specific or giving responses on detailed questions…because I’m not a licensed CPA. I don’t want to give any wrong information. I definitely recommend working with an investor-friendly accountant who can be the best on guiding you through it. Amanda Han is on here, a blog writer, and I’ve used her for years.

  3. Jerry Kisasonak

    1. The age of the property has nothing to do with the 27.5 depreciation schedule. So, theoretically, a new home and a home that’s 100 years old both depreciate to $0 in value 27.5 from the time you buy it/place it in service. Rational? No. Tax code? Yes!

    2. To my knowledge rental losses, on paper or actual, cannot be written off against W2 income – which is “bad income” for this very reason.

  4. William Morrison

    Great read Ali.
    I agree 100%. The depreciation allowances and the effect on rental income are a great benefit. It did bring back a tax issue I had a few years back. So the following rant is based on that and not the basic benefits of depreciation in general and the positive effect on rental income.

    Bottom line beware of the effect of Bonus Depreciation and State De-Coupling of your Federal Tax filing. If you are aware don’t read farther. Grin.

    Be careful with Federal Bonus Depreciation and the associated pain for the life of the item depreciated.
    Nearly all states before 2002 used the federal depreciation definitions and allowances. The Bonus Depreciation created in March 2002 created a deduction that threatened the states revenue in a large way. One of the first estimates for Maryland was an $800 million loss the first year in revenue.

    30 states plus DC in 2002 were decoupled if you used it, not sure how many now. It is still true for Maryland.

    No I’m not a CPA, Tax Professional or Accountant, but I do know for a few years they didn’t do a very good job of understanding or implementing it. The states didn’t explain it well either.
    Maryland revised their Administrative Releases several times because it was impossible to understand and if you think it’s straight now, read the filing instructions and ask five professionals what it means in English. Grin. I have and each has laughed with me as we read it.

    Here’s the deal, if your AGI limits losses you can apply yearly and they carry forward the Bonus Depreciation probably does not help in that year anyway. Maryland’s method is that you basically have to prepare or have prepared two Federal returns every year for life of the depreciated items using Bonus Depreciation, yes I went to the state. You use the second Federal one not filed but filled out as if you didn’t use the Bonus Depreciation for you state filing.

    I file in three states and Maryland just happened to be the one I used as an example. They wanted a copy of both Federal Tax forms as prepared.

    It’s been around for a while now so I’m sure the answers are a little more consistent now from the professionals. I was lucky enough to be able to file a 1040x to fix mine (changed the depreciation method). Because of AGI limit there was no change in the bottom line and both the Fed and Maryland were happy and my returns in all three states remain coupled.

    Even if it helps you now (your AGI doesn’t limit your deductions) consider the long term requirement and the benefit to you. Don’t you hope to increase you income to the point where you are limited some day? Grin. Take your actions in life on purpose, not by accident.

    Using the Bonus Depreciation on a $500,000 3 Axis Haus machine in a manufacturing business might be worth the additional filing/preparation requirement but maybe not for the small amount you may be handling.

    Just glancing at a 2016 list, AZ, AR, CA, CT, DC, MD, NC do not conform to the Federal treatment of Bonus Depreciation. The list was much longer, I just checked a few.

  5. Also not a tax expert but isn’t your ability to claim losses limited by your IRS status (Real Estate Professional vs. Passive investor) ?
    looking at the tax code just working full time in real estate or having a realtor license does not automatically qualify one as a “professional”. The bar is set high by the IRS to qualify.
    There was a good article on this previously on this forum.
    Now, having said the above… good article! the tax advantages’ of investing are significant. You give excellent advice… consult a qualified tax expert.

    • Matthew Chappel

      You’re correct that the “Professional” qualification doesn’t stop you from writing off rental expenses against rental income. However, you definitely cannot write off rental expenses against *W2 Income* unless you are qualified by the IRS as a “Real Estate Professional”, which, as Sid state, has a lot of requirements.

      If you’re working enough hours to earn W2 income, you most likely are not qualified in the eyes of the IRS as a real estate professional.

  6. Daniel Dietz

    This is a link outside of BP that I have used for reference before and it seems accurate from what my tax guy says too ;

    The summary of it is that passive loses are not allowed to offset current income, UNLESS these apply;
    Exceptions to Passive Loss Rules

    There are only two exceptions to the passive loss (“PAL”) rules:

    you or your spouse qualify as a real estate professional, or
    your income is small enough that you can use the $25,000 annual rental loss allowance.

    Property owners with modified adjusted gross incomes of $100,000 or less may deduct up to $25,000 in rental real estate losses per year if they “actively participate” in the rental activity. You actively participate if you are involved in meaningful management decisions regarding the rental property and have more than a 10% ownership interest in the property. This allowance is phased out for taxpayers whose MAGI exceeds $100,000 and eliminated entirely when it exceeds $150,000. Thus, it is useless for high-income landlords.

    The other exception to the PAL rules is the one for real estate professionals. Unlike the $25,000 exception described above, this is a complete exemption from the rules–that is, landlords who qualify as real estate professionals may deduct any amount of losses from their other non-passive income.

    To qualify for this exemption, you (or your spouse) must spend more than half of your total working hours during the year in one or more real property businesses–a minimum of 751 hours is required. In addition, you must “materially participate” in your rental activity. This requires that you work a certain number of hours at your rental activity during the year. For example, you would materially participate if you work at least 500 hours during the year at the activity. You can qualify in other ways as well.

    If you own more than one rental property, you are required to materially participate for each rental property you own unless you file an election with the IRS to treat all your properties together as one single activity. This way, you can combine the time you spend working on each rental property to satisfy the material participation test. If you fail to file the election, you’ll have to materially participate for each rental property you own. For most landlords, this is impossible to do, which makes filing an election very important.

  7. William Morrison

    Even if your total loss is limited, your rents are reduced by the deprecation before the limits are applied.
    If you have more losses than income you may just have to carry forward those losses.
    You still get the rent with the tax advantage.

  8. Huiping Sheng

    Thanks Dan Dietz for excellent explanation.

    Just a part-time agent and full time w-2 work, so I will not qualified for a professional write-off. If my first-year RE related cost is higher than my RE agent and rental property income, can I carry this cost to next year or further?

    Thanks again.

  9. Joe Canfield

    There are lots of caveats to the statement you don’t have to pay taxes on income received from residential real estate. I don’t believe that is the right way to say it. While there are many ways to shield rental income, which is one of the more attractive options to investing in real estate, that income still needs to be recorded and is considered income. Be careful and consult a tax professional before you make any decisions on how you should manage your taxes. There is a reason they get paid to do tax returns and the rest of us don’t. You should be educated so you can engage in the conversation, challenge their advice, and ultimately make the decision you think is best for you, but in my opinion this is not the place to go it alone.

  10. Prasad j.

    This article does not talk about categorization of investors for offsetting rental losses with other income. If the investor is not working full time in real estate and has agi upwards of 150k then he cannot offset rental losses with other income. Would have been nicer if article a little more deep into that, everything else that’s said is fairly standard

    • Ali Boone

      Totally understand, Prasad. It is mostly standard, but a lot of people don’t know it. I try to keep things pretty high-level, and just alert people to things they need to do further research on. Great call about making sure folks understand the limitations. Consulting with a professional is exactly where that would/should come in. But great input on reminding people of something to research further! I’m not a tax professional, so I am careful to get into too much details on conversations like these.

    • Ali Boone

      Well and Rockford, be sure though that you guys are clear on what constitutes a good property that would make a good rental property investment. A lot don’t. So being up on how to run the math and such is key. But get those things down and you’re good!

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