The Ultimate Guide to Real Estate Investment Tax Benefits


I have a good friend I would like to introduce you to.

His name is Sam, but most people know him by “Uncle Sam.”

That’s right, Uncle Sam — the good ‘ol U.S.A. Now, most people don’t think of the US Government as their friend, but most people are not real estate investors. If you are, and you know how to treat Uncle Sam right, he’s got some pretty terrific benefits in store for you.

This post is going to dive deep (and I mean DEEP… with over 3,000 words) into the tax benefits of being a real estate investor. But first, the obligatory disclaimer:

I am not a CPA. I’m also not a lawyer, doctor, or your mother. I’m a monkey in a room, frantically typing out words on a keyboard trying to produce Shakespeare. This information, while I’ve spent hours and hours researching, is still just my opinion on what I’ve learned. Please consult with a qualified (and real estate-savvy) accountant before making any decisions.

logo440aThat said, I did work with Amanda Han from Keystone CPA (my own amazing real estate-friendly CPA) on this article to make sure everything was legit. If you need a CPA for your business, I highly recommend Keystone CPA. They do all my taxes, and my tax-life has become 1,000x easier since I hired them.

Now that we’ve got that out of the way, let’s get into this beast-of-a-post. Extra brownie points for those who make it through the whole thing. And to help, I’ve hidden a secret message in the text that will lead you to my buried treasure on a Caribbean island.

(Okay, that’s a lie. But for those who seek to truly understand these benefits, incredible treasures ARE in store for your future because they won’t be in Uncle Sam’s pocket!) 

Let’s get to the list, and we’ll start out with the most obvious one: deductions.

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1. Deductions

As a rental property owner, you are able to deduct nearly all the expenses you’ll pay to manage your property. Everything from the mortgage interest you pay on the loan all the way down to the paper you buy for your printer (if you are using that printer primarily for real estate investing purposes, that is).

Of course, I’m not sure I’d necessarily qualify this as a “huge benefit” of rental property investing because you are still having to spend the money on those items. Who cares if you can deduct the cost of paper because you own a rental property — because if you didn’t have the rental, you wouldn’t have spent the money on the paper in the first place.

However, where this deduction can come in handy are on the areas of your life that are shared with non-real estate activities. For example, if you have a home office, you may be able to deduct a portion of your home expenses (fax machine, internet bill, cell phone bill, mortgage interest, home repairs, etc.) equal to the portion that your office takes up in your house.

Related: 5 Clever (& Legal) Tax Strategies to Save Real Estate Investors Money

Or if you need to drive up to check on your rental property and swing by the grocery store on the way back, you might be able to deduct the cost of your trip using the IRS standard mileage deduction (currently 57.5 cents per mile). The benefit of this, of course, is that it’s not like you wouldn’t have those bills anyway without a rental, so if you itemize those deductions carefully, you may be able to save significantly at tax time. You needed a cell phone, you needed that office, you needed that trip to the grocery store. Only now, you might be able to deduct some of them because of the business use.

Things like meals, travel, and other similar expenses may also be able to be deducted, but don’t assume you can go to Disney World with your family and write off the whole trip because you spent a few hours looking at real estate. That’s called “cheating,” and you’ll likely find yourself in some hot water if you ever get audited. However, just like your home office deduction, perhaps you can deduct a portion of your expenses to help offset the costs some.

Obviously — and I’ll say this numerous times in this post — talk to your CPA about what you can and cannot deduct.

2. Long-Term Capital Gains

Capital gains are the profits you make when you sell a property (that’s a very simplistic definition, but it will work for our discussion). When you sell a property and make a gain, the IRS is going to want their share. However, that profit is taxed in one of two ways:

  1. Short Term Capital Gains
  2. Long Term Capital Gains

Short term capital gains means that the gain was made while holding the investment for one year or less, where long term capital gains mean the gain was made while holding the investment for over one year. As a rental property owner, it’s most likely you’ll have owned the property for longer than a year, so you’ll most likely only need to pay the long term capital gains tax, which can be much more favorable than the short term tax.

Currently, there is not special tax treatment for short term capital gains, so you’ll simply be responsible for paying tax at whatever your regular IRS-defined tax bracket is, based on your income. For example, in 2015, ordinary tax rates range from 10% to 39.6%, depending on how much total taxable income you received during the year.

On the other hand, in this same year, the long term capital gains tax are either 0%, 15%, or 20%, depending on what income tax bracket you are in. As you can see in the chart below, married couples filing jointly in the 10% and 15% income tax bracket pay 0% in long term capital gains, only those in the top income bracket pay 20%, and everyone else pays 15%.

2015 Tax Bracket and Long Term Capital Gains

In other words, let’s just say last year your neighbor made $60,000 per year as a self-employed business owner. You also earned $60,000, but $40,000 of your income came from rents and the other $20,000 came from a property you sold. Your neighbor’s $60,000 was taxed at 15%, but he also had to pay 15% in self employment tax. You, on the other hand, paid $0 in taxes on the $20,000 in capital gains and no self-employment tax on any of your income. The only tax due was your 15% income tax on the $40k in rental income, but with all the deductions (including depreciation and the standard deduction), you ended up paying next to nothing, while your neighbor lost almost 1/3 of his income to the IRS.

Same income amount… far different tax treatments. 

Man, it feels good to be a real estate investor.

3. Depreciation

One of the deductions you’ll be able to claim on your taxes each year is so powerful it deserves its own section here!

Depreciation is a deduction taken on materials that breaks down, but not all in one year. It’s not a concept unique to real estate, but is used in most businesses in America. To understand the concept, let me try to explain it in more detail.

Let’s pretend you own an office supply store and you needed to purchase a new $5,000 printer for your business. Because the printer is a business expense, the IRS allows you to deduct, or “write off,” the cost of the printer. However, the IRS knows that the printer is going to last more than one year, so they don’t want you to write off the entire cost of the printer in the year you bought it. That would be too easy. Instead, you have to spread out the deduction over the life of the printer, as defined by the IRS in Publication 946, Appendix B. (In this case, the IRS says a printer is depreciable over five years.) So, you could deduct a portion of the $5,000 the first year, another portion the second year, and so on until you depreciate the entire printer. You are still getting to deduct the total cost, but you must do so over time.

Make sense?

Now, residential real estate is also an asset that breaks down over time, right? The roof is failing, the siding will fall off, the wood is slowly decaying. As such, the IRS allows real estate investors to deduct the cost of the building just like you might deduct a printer. (Notice that I said “building” — not land. Land doesn’t break down over time; even the IRS is smart enough to know that one!)

The IRS has determined that the deductible life of a piece of residential real estate is 27.5 years and for commercial real estate it is 39 years. In other words, as a rental property owner, you are able to deduct the value of your building over that length of time.

But my property isn’t going to disappear in 27.5 years!” you exclaim.

And you are right. This is why depreciation may be a benefit to you, the landlord. We all know that property values generally go up over time, and anything that breaks down on the property we are able to deduct separately anyway. Therefore, depreciation on real estate is often known as a “phantom deduction” because although we deduct the cost, the actual loss never really occurs.

Let me illustrate a quick example involving real estate. Let’s just say you bought a house for $100,000. You have determined (probably using the ratio between land and building defined by your county appraiser) that the building itself makes up 85% of the value of that property, or $85,000, and the land makes up 15%, or $15,000. Only the $85,000, therefore, is depreciable. Now, that $85,000 will be spread out over 27.5 years, so we simply divide $85,000 by 27.5 to get:

$85,0000 / 27.5 = $3,091

Therefore, we are able to “deduct” $3,091.00 every single year for the next 27.5 years on the property. Now, how does this come in handy?

Well, let’s say that your rental house produced $250 per month in cash flow for you after all the income and expenses have been calculated. Normally, as an investor, you would need to pay taxes on that income because, of course, it IS income. That cash is what’s left over in your rental business. BUT because of depreciation on the property, you won’t pay ANY taxes on that (yet). That $250 per month works out to $3,000 in income over the year, but once you deduct the depreciation expense of $3,091 per year, you find that — on paper — you actually LOST $91 on your rental property.

This is what is known as a “paper loss” because, of course, on paper it looks like you lost money, but in reality you made money. Try doing that with your W-2 job… it’s not going to happen.

Now, that was a small example of depreciation on a single family house. Think of what could happen as you grow your portfolio. Imagine if you owned $2,000,000 worth of real estate, and, let’s say, 85% of that is depreciable. Now you are looking at $61,818 per year in deductions on the income you make from those properties, even though you never actually experienced that loss.

Does that seem too good to be true?

Well, it is, sorta.

Related: Your Tax Write-Offs Could Affect Your Ability to Get a Loan: Here’s How

The Dark Side of Depreciation (Recapture)

As much as I want to believe that the IRS is my friend and we could hang out together, grab some drinks, and talk about life… it’s not entirely true.

The IRS is out to get all the money it deserves, and, as such, the piper may still need to get paid. This is usually done when the real estate property is sold. That’s right: All that money you “deducted” over the years of you owning the rental property may be paid back to the IRS in a process known as “recapture of depreciation.” Currently, that amount is taxed at a hefty 25%.

Perhaps the best way to explain this is by using an example.

Let’s go back to that same example we talked about earlier with the $100,000 house, depreciated at $3,091 per year. If we owned the property for ten years, we would have deducted $30,910 in total during those years and not had to pay taxes on that amount. However, when we sold, that $30,910 may be taxed at a 25% rate, in addition to any other capital gains taxes you would need to pay with the sale.

What a lot of people may not know is that depreciation recapture is only applicable to the extent that you had gain on the sale of the property. Lets say for example that we sold this property for a gain on $20,000. In this scenario, even though we have taken $30,910 in depreciation, we my only need to pay recapture taxes on $20,000. This is sort of a perk that the IRS gives us by saying, “Hey, if you didn’t make money, then I will just let you have that old depreciation free of charge.”

Depreciation doesn’t seem so great after all, does it? And if you are thinking, “Well, I just won’t take the depreciation on my taxes,” think again. The IRS may require a person to pay that 25% recapture of depreciation charge no matter what, whether or not you took the depreciation. So of course, you better take the depreciation or you’ll be paying taxes twice to the IRS.

Let me end with three points of consolation about this recapture of depreciation:

  1. Hopefully, if you are selling the property, you’ll be making a pretty good profit. After all, the longer you hold the property, the more of the property you will have paid off, resulting in more equity and more cash at closing. Hopefully the property has climbed in value as well, more than the depreciation cost.
  2. During all this time that you didn’t have to pay taxes on that income, you were essentially using the government’s money tax free. So even if you do have to pay it back at a 25% rate (which might be lower than your income tax rate anyway), it’s still not due until you sell. Just think: the IRS could have charged you that amount each year.
  3. There is one surefire strategy you can use to avoid paying the Recapture of Depreciation Tax through the use of a 1031 Exchange. In a 1031 Exchange, also known as a like-kind exchange or a Starker exchange, an investor can purchase another property and carry your proceeds, and your tax basis, forward into the next property. Essentially, you could continue to do this for the rest of your life, always trading up to the next big deal and never paying that tax. Of course, someday when you finally do cash out, you’ll have a large accumulated tax bill, but likely you’ll be so rich it won’t matter… or you’ll be dead. Either way, win!

Well, since we touched on the 1031 Exchange, let’s talk about that next…

4. 1031 Exchanges

The 1031 Exchange is a legal strategy used by many savvy real estate investors to bypass that whole “paying taxes” thing when they sell. Named after the IRS tax code that brought the exchange into existence (Section 1031), the 1031 Exchange allows an individual to sell an asset and carry their basis forward into a new, higher priced property. In other words, a real estate investor can use this tax code to sell a property and use the profit to buy a new one… and kick the can down the road and defer paying taxes until that next property is sold (unless, of course, they use another 1031 Exchange).

I know, that’s confusing. Let me explain it with a story.

John has owned a duplex for several years, and over time, the property has gone up in value considerably. He purchased the property for just $75,000, but today it’s worth almost $200,000. If he were to sell, he’d likely be stuck with paying long-term capital gains tax on all that sweet profit, as well as the recapture of depreciation. If his long-term capital gains tax rate was 15% and his profit was $125,000, that’s $18,750 directly to the IRS for the capital gains tax and potentially another several thousands dollars for the “recapture of depreciation” — but not if he uses a 1031 Exchange. John instead takes that money in profit and uses it as a down payment on another property — a $1,000,000 apartment complex. Because he didn’t have to pay that $18,750 to the government, John was able to use it as part of his 20% down payment, allowing him to afford to buy another $93,750 worth of property (because 20% of $93,750 is $18,750).

Imagine if five years later John does the same strategy again, and again, and again. He could continue to invest in increasingly expensive properties, growing his net worth without needing to fork over money to the IRS each time.

Of course, the IRS has some pretty strict rules that govern the 1031 Exchange. These rules MUST be followed strictly, or the investor may lose the entire benefit and be forced to pay the tax. These rules are:

  • The Exchange Must Be For a “Like-Kind Asset.” In other words, you can’t sell a house and buy a McDonald’s franchise. However, “like-kind” is a loosely defined term, so you could sell a house and buy an apartment, a piece of land, or a mobile home park.
  • There Are Time Limits. After the sale of your property, the clock starts ticking on two important timelines: the identification window and the closing window. The IRS requires that you identify the property you plan to buy within 45 days (you can identify three possible properties), and you also must close on that property within 180 days. For those experienced real estate investors out there, you probably are already thinking, “Well… that doesn’t seem to be a lot of time!” You are right. The IRS, for some unknown reason, makes investors move very quickly to make the 1031-Exchange happen.
  • You Can’t Touch the Cash. Finally, when you sell your property, you cannot touch the profit from the sale. Instead, you must use an intermediary who will hold onto the cash while you wait to close on the new deal. Keep in mind, you can take out some of the profit; you’ll just need to pay taxes on whatever you touch.

As you can see, these rules may make it difficult to properly carry out a 1031 Exchange, especially when good deals are hard to find. There is no sense in buying a terrible property just because you want to avoid paying a 15% tax on your profit. For this reason, some investors simply pay the tax and avoid the 1031. But for those who are willing to take on the government’s “1031 Exchange challenge,” faster growth and larger profits can result.

5. No Self-Employment or FICA Tax

Another tax benefit of investing in rental properties is that the income you received is not generally taxed as “earned income” and therefore not subject to a major tax most Americans pay: FICA/Self-Employment Tax, which both help to fund Social Security and Medicare.

FICA (short for Federal Insurance Contributions Act) is a term that you’ve likely seen on your pay stub if you have a W-2 job. This is a 15.3% tax that is split 50/50 between the employer and the employee. Of course, if you are self-employed and have no employer, you are responsible for the full 15.3%, which is known as Self-Employment Tax. 15.3% is no laughing matter, but luckily for real estate investors, we have something to laugh at! The US Government does not currently look at rental real estate as a job or self-employed business, so that tax is generally not due.

Keep in mind, however, that this may depend on how you legally structure your real estate holdings. Certain strategies, like holding properties in a c-corporation and paying yourself a salary or paying yourself a management fee, could trigger the FICA tax, so check with your CPA to make sure you are optimized for the best tax treatment.

Related: 3 Reasons You Should LOVE the Home Office Tax Deduction

6. “Tax Free” Refinances/2nd Mortgages

Next, let’s talk about one of my favorite tax benefits of investing in real estate: tax free borrowing!

Imagine with me that you own a piece of real estate worth $200,000, but you only owe $100,000 on that property. You could potentially take out a line of credit on that property OR refinance the property to pull out your equity. So, let’s just say we went to the bank and refinanced that property for $160,000, obtaining a brand-new loan and paying off of the old one. After paying the original $100,000 loan off, we have $60,000 left over to do pretty much whatever we want with.

The best part is: Although this is cash in your pocket that you just pulled out of thin air, you don’t need to pay taxes on this. Of course, this makes sense since you didn’t actually sell anything. But it’s not often you can get a big chunk of money and not pay taxes. Sure, you’ll need to pay taxes someday when you sell the property, but you can use that money right now with no tax at all. Use it to buy more rentals, lend to other investors, or take a trip to Fiji. It’s your money, do what you want… tax free.

Even better, if the proceeds from the refinance was used for your primary home or for another investment property, you may be able to deduct the interest paid on that loan! So, not only can you borrow the money tax free, but you can possibly lessen your tax bill at the end of the year for doing so.


Taxes are inevitable, as is death. But unlike the rest of the working world, the IRS actually seems to like real estate investors, so the sting is not quite as sharp.

The US tax code is incredibly complex, and every strategy has rules that must be followed, exemptions that are allowed, loopholes that only the rich seem to know about, and penalties if not performed correctly. For this reason, it is absolutely imperative that you talk with an investor-savvy CPA when plotting your tax strategy. I’ve been investing for almost ten years now and still barely understand the concepts I just tried to explain to you. You cannot do this on your own; you need help.

And remember, as you build wealth, a good CPA will save you more money than they cost. And they might just keep you out of jail!

If you made it to the end of this post, you probably have a question, comment, or some more insight to provide…

Be sure to share your comments below!

About Author

Brandon Turner

Brandon Turner (G+ | Twitter) spends a lot of time on Like... seriously... a lot. Oh, and he is also an active real estate investor, entrepreneur, traveler, third-person speaker, husband, and author of "The Book on Investing in Real Estate with No (and Low) Money Down", and "The Book on Rental Property Investing" which you should probably read if you want to do more deals.


  1. Tim Hawkins


    We were able to use a Cost Segregation Study on our 8 rentals to move some additional 27.5 depreciation into the first 15.

    Additionally, I could not find supporting evidence/rules by the IRS for using a 80 or 85 percent building to land ratio as a basis for the depreciation (a value typically used by CPA’s, but is not supported); but what I did find in the IRS ATG were references to ARV based on insurance, market value, and another method I can’t remember at the moment. We used the market value approach, based on the MLS for nearby lots, of similar size (10 of them), then backed into the building value from that. This method added another $25k of depreciation for each of the 7 (the 8th one got way more) — useful when the dirt is less expensive than the brick.

    Based on this, you should be able to add two more methods to your Ultimate Guide..

    • Brandon Turner

      Hey Tim, rock on! Yeah, I was gonna write about the Cost Segregation but thought I better hold off for another article – this one was getting beast-y!

      And yeah, I’ve never seen the “80 or 85%” number, I only used it as an example. I just look at how my country ratios the difference between land and building and use that ratio. I’ll have to look more into the strategy you did, to see if I can capitalize on that. Thanks for the comment!

      • Depreciation can be even higher 90-95%. State where farm land i.e Wisconsin is so cheap. Look at tax assessor web and check to confirm land values. for commercial properties as well.

        • Tim Hawkins on

          Yes, that sounds about right. Purchase price all at about $165, with depreciation at about $158 (normally about $132).

  2. Adam Middaugh

    A wonderful primer to the tax benefits that investors can (and should!) take advantage of. Thank you, Brandon! As an aside, do you have any book or website recommendations for those wanting to explore the topic further?

  3. Curtis Bidwell

    Good info! But don’t forget to take full advantage of the mileage deduction the IRS grants us: According to their website . . .

    “Beginning on Jan. 1, 2015, the standard mileage rates for the use of a car, van, pickup or panel truck will be:
    •57.5 cents per mile for business miles driven, up from 56 cents in 2014”

  4. Ken Klatt

    Thanks for the article Brandon and insight into Tax benefits! This gives me hope after looking at my W-2..

    For 1031 exchanges, are you able to split up the money you sold the original house for and buy multiple ‘like-kind’ properties, or can you only go 1 for 1? Also, can you exchange just a certain amount of the price you sold the original house for and then cash out the rest, paying a capital gains tax on that part?

    Thanks again!

    • Brandon Turner

      Hey Ken,

      So, I’m not a CPA and never done a 1031… but I believe yes on both – you can buy multiple ones, and yes, you can take some of the profit and just pay taxes on that amount you take. (someone correct me if I’m wrong!)

      Thanks Ken!

  5. I noticed many investors had houses foreclosed by the bank during the downturn.
    How does the IRS determine whether you have to pay back depreciation in that case? Some of them borrowed to the hilt (tax free), then let the property go back to the bank. Do they also owe no depreciation since they did not sell for a gain?

  6. Kate H.

    Thanks Brandon, I love these long articles that both give a nice broad overview and actually go deeper into the subject matter. I think taxes are both one of the most scary and most fascinating parts of real estate investing.

        • @Christy, toilets and tenants — PM is no fun. Make sure you have plenty in the bank to pay the mortgage when the rent doesn’t come in for months at a time, and you have to spend $5k to refurbish your unit…. This effort takes a toll. Also, do it correctly, you really, really need to do you accounting perfectly correct; or risk spend a ton of money in additional taxes or expenses you hadn’t counted on. We’re 8 years in, with 7 to go…. 15 years (at the min) is a big commitment. Good luck.

    • I’d research this a little closer; where my understanding is that if you’re not a “RE Professional” you are limited to $25k of depreciation, if you are a RE Pro (working at least 750 hours/year with contemporaneous records) then the amount is unlimited. This issue is in the blogs, and you’ll find that the IRS often wins these (where the IRS says it’s a passive investment).

    • Shaun Spalding

      From what I’ve read, and I’m no expert, but the deductions also depend upon your income. You can take the full deduction of your expenses up to $25k until your income (married filing jointly) is $100,000 or less. If your income is between $100k and $150k, then you can only take 25% of deductions with max of 25% of $25k. Above that and you get to deduct nothing.

      But, if your Modified Gross Income is above $150k, then all your deductions that your were cheated out of accumulate and will offset your capital gains when and if you sell the property. This was put into place by the IRS to prevent the wealthy from using property investments to reduce their active income and bring them into lower tax brackets, etc.

      But, you can make your passive income and expenses/ deductions work against your active income by calling yourself a real estate professional. This is the loophole given back to the real estate agents, contractors, mortgage people to allow them to count their property expenses against their business.

      This post is getting too long. Let me know if you want to hear more about the active/ passive income buckets and the real estate professional angle.

      • John Briggs


        Please consult with a CPA on the active/passive rules. The unallowed passive losses carry forward until the property is sold or you have passive income to offset the losses. So 100% of your expenses will eventually be used. Even if your strategy is to buy and hold, I’ve never seen a client not end up getting all the expenses. Yes it sucks it doesn’t always happen in the year they incur the cost, but they eventually get the tax benefit.

        I do agree that being able to call yourself a real estate professional is a great benefit and it does allow you to avoid the hairy-ness of passive tax rules, but make sure you qualify as a real estate professional based on IRS rules.

  7. Pyrrha Rivers

    Thanks for yet another informative article!
    Prompted me to wonder what role the 1031 exchange play when you sell a property with owner financing. Do you have to pay for the gain when all payments are made? What about when the buyer does not perform, you keep the down payment and start anew with another buyer? How are you taxed on that profit?

  8. Christine O'Meara on

    Love this article!!!!
    I will read it till I learn it by heart.
    The comments are excellent , as well!
    More reasons why one should get into this game!

  9. Christopher Morin

    Hey Brandon, great article! I know you’re not a CPA, but what about claiming huge losses for a sale? Obviously the investor wants to avoid these huge losses… but when dealing with motivated sellers, they often want to know what impact selling their home for $50,000 when they bought it for $100,000? Can they carry these losses over into the next tax years as well?

  10. Bradley tetu

    Great article Brandon, I had no idea that Depreciation Recapture existed. I only have one rental at the moment and I may end up selling it to the current tenant, so I am glad I read about it here so it is not a surprise when I sell it in a few years.


  11. The book that I found useful is, John’s writing style can get a little doom and gloom and wordy, but he provides good information for the cost.

    Books are your cheapest form of Knowledge. Take advantage. No matter where you take your information from, keep in mind that taxation changes yearly, so you should subscribe to Personal Finance and Real Estate and Taxation blogs. Very few information sources contain all of the information, so you’ll have to harvest it from multiple sources.

    BTW, I copy-paste useful articles into MS Word documents, including the original URL, and have a small library broken down into a nice Category-based folder structure for later review when I get to things like 1031 Exchanges, I have a ready-made bookshelf.

  12. Tyson Cox


    In part 6, “Tax Free” Refinances/2nd Mortgages, you talk about being able to get cash out by refinancing to 80% LTV. As a non-owner occupied investor, I have not been able to find anyone who will give me a first or second on a non-owner occupied property for cash out for anything over 60-70% LTV. I have found a programs that will allow 80% LTV if the money is used for improvements or the down on another property their program will finance.

    I understand that this article was meant to have examples and that the examples may not work for everyone. My question is: Have you found any traditional lenders who will give 80% LTV for cash out on a residential mortgage for a non-owner occupied, 1-4 unit property? I have great rates and am not looking to add 1-3 points to my interest rate by using hard money or anything of that sort.

    Thanks for any insight you might have. I would love to be able to get to that equity 🙂

  13. Kevin Izquierdo

    “Well, let’s say that your rental house produced $250 per month in cash flow for you after all the income and expenses have been calculated. Normally, as an investor, you would need to pay taxes on that income because, of course, it IS income. That cash is what’s left over in your rental business. BUT because of depreciation on the property, you won’t pay ANY taxes on that (yet). That $250 per month works out to $3,000 in income over the year, but once you deduct the depreciation expense of $3,091 per year, you find that — on paper — you actually LOST $91 on your rental property.”

    This was the only thing I didnt understand. Can anyone expand on this? Why would you lose 91$ if youre getting the 3.091 and the 3,000 from the cash flow? Why are we subtracting these numbers?

    • it is an interest free loan from the IRS. When you sell, you will have to pay back this “loan” on the taxes on the additional $3000 of income in your example. I believe that this was probably instituted so that a person who has a mortgage on a property does not have to pay taxes on income that goes toward the principal of your mortgage. Otherwise, it could force an investor with a close to break even property to go into the red and be forced to sell the property in order to access the principal in order to pay the taxes. (You would have income, but no cash since it was part of the mortgage payment that went toward principal. Only interest is tax deductible)

      • John Wright

        The core logic to this depreciation is not so much that it is a “loan” but that it is truly and “future expense” for which the IRS is “allowing” you “save.” You may not have a realized cost this year for the $3,091, but next year, or 5 or 10 years from now, you will have to spend this “saved” money. In theory, over the course of 29.7 years, you will spend 29.7 * $3,091 and will have neither gain nor loss.

        This coincides with how the IRS defines “repair” and “capital improvement.” You may immediately deduct a “repair” but you must depreciate a “capital improvement.” And in most very simplistic terms, the IRS defines a repair as a low cost one-off (think less than $500) and a “capital improvement” as anything else. So fixing a hole in the wall, broken window, leaky faucet are typical repairs. Replacing the roof, new HVAC equipment, re-doing the plumbing, bathroom or kitchen makeovers, are capital improvements.

        The pros of repairs are nice as they have an immediate tax benefit. Con is that a true repair is a true expense that does not improve property value (just maintains livability) and so is a net expense even after tax deduction.

        Con of capital improvement is delayed immediate tax deduction for an immediate expenditure. Pro is two-fold as (1) in the right environment the work done might result in a > 1x increase in property value (think house flippers) and (2) the cost of the capital improvement increases your cost basis so when you sell the property in the future, the paper profit is reduced and thus you pay less taxes.

  14. Jim T.

    Thank you for the article Brandon. Just a small clarification on the real estate depreciation recapture. It is at ordinary income rates with a maximum of 25%, not simply 25%. In practice, it is likely 25% for everybody so no difference but for those showing very low income, it could make a difference.

  15. Dale Forney

    Hi Brandon,

    I’m here in the great NW as well (Snohomish county). Jumping in with both feet into BP. Have been listing to your many webinar replays (and some live ones). Thanks for sharing your knowledge. You’ve got me motivated.

    Question on Keystone CPA…Thanks for mentioning them. I will reach out to them directly, but I”m curious if there are any challenges or difficulties given that they are not local (you in WA, they in CA I think). I’ve got 4 rentals, purchased in 2012 under personal name (cringe, but have umbrella ins). Learned many lessons….need to set up LLC, find good CPA, attorney, lender, etc. Would appreciate your comments on Keystone, given we are in same region.

    Know you are very busy. Thanks for any insight/response. Your willingness and ability to educate is more valuable than you realize.


  16. William Prickett

    Great summary of the real estate related tax benefits. I’m confused about how deductions/losses affect personal active income. From what I have read on the IRS website, non-professionals (under 750 hours per year) can only deduct passive investment expenses from passive income, meaning at best your deductions will only offset all of your rental income. In this case, you have exactly the same tax liability as you did before investing. That would mean the paper loss that will likely occur after depreciation does you no good other than to carry over and offset future rental income should you reach a point where you are actually producing profits. Is this correct? Until I read the actual provision I was under the impression that you could deduct that paper loss from your active income if you have a full-time job.

  17. I must have the worst accountant possible. I have two rental condos that are in an LLC that I formed specifically so that I could write off all related expenses and, thus, reap the tax benefit at the end of the year. This account has indicated that we are “Not Active Real Estate Investors” so we’re not able to write off any of these expenses ? Is what my account is telling me accurate? It sounds like I need a new accountant that knows what he/she is doing.
    Any feedback would be greatly appreciated.

  18. Michael Strobel


    Love this. Just bought my first duplex and Im looking for the best ways to use the tax laws to my advantage. I just bought a duplex built in 1970 (46 year old) Quick question about depreciation. If a home has a depreciation lifecycle of 27.5 years. If previous owners used the 27.5 years of depreciation, does that mean I no longer can claim that when I file for taxes?

    Fantastic article. Thanks for all the knowledge you keep dishing on the site. From a newbie investor, I cant even begin to express how much BP has helped me in my RE knowledge.

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