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Tax Benefits Of Real Estate Investing: What Investors Should Know

Melissa Brock7-minute read
UPDATED: June 01, 2023

You might perk up at the mention of tax benefits – who doesn't? But did you know you can also get tax benefits through real estate investing?

As a real estate investor, you incur many yearly expenses to run and maintain your rental property. However, each expense represents a potential tax deduction you can claim to offset some of the rental income you've earned.

It's important to learn as much as you can about the tax benefits of real estate investing prior to getting started so you can unlock potential tax savings.

Does Investing In Real Estate Reduce Taxes?

Yes, you can reduce your taxes by investing in real estate. In fact, in the world of real estate investing, having a rental property for rental income allows you a double benefit – cash flow and tax incentives for real estate investments.

Real estate can reduce taxes in several ways, which we'll look at in more detail in this article.

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6 Tax Benefits Of Real Estate Investing

Real estate investment benefits and tax incentives include the following: deductions and write-offs, depreciation, passive income and pass-through deductions, capital gains tax, tax incentive programs and self-employment FICA tax. We'll take a look at each type of tax savings. 

1. Deductions And Write-Offs

You may take advantage of tax deductions and write-offs. According to the IRS, the terms refer to the same thing – expenses you can subtract from your income to lower the amount of tax you owe. A few items that qualify for real estate investor tax deductions and write-offs include the following:

  • Mortgage interest: Mortgage interest refers to the portion of a monthly mortgage payment that you pay out in the form of interest. Interest is the amount you pay to your lender for borrowing money. You'll get a statement from your lender showing the total interest you paid on your loan during the past year.
  • Property taxes: You can also deduct property taxes, which you pay based on your state's assessment of your property.
  • Property management expenses: If you don't handle your own property maintenance or live out of state, a property management company may handle the processes of finding tenants, handling repairs, collecting rent and more. You can deduct the amount you pay the property management company to do those services.
  • Maintenance and repairs: Yes, tax-deductible home improvements are a thing, and it is also with rental property. For example, you can deduct small purchases like lightbulbs, furnace filters or major expenses like a new roof or HVAC system.
  • Business expenses: You can always deduct business expenses, like lawyer fees when purchasing your business, accounting fees, advertising expenses, office space, office supplies, internet expenses and other costs of running your business.

The benefits of tax deductions might look like this: Assume you have a rental property that has a profit of $6,000 each year. Now, let's assume that you pay a total of $3,000 combined to cover the cost of your property manager, replacing a water heater and new light for the front porch. Instead of paying taxes on $6,000, you'd pay taxes on $3,000.

2. Depreciation

Depreciation deductions are annual income tax deductions on rental property that account for the property's wear and tear, or deterioration, over time. You can claim a deduction for your real estate business for income tax purposes.

The amount you can deduct depends on a few factors, including market value, the property's recovery period and the method of depreciation used. The most common method is the modified accelerated cost recovery system, which depreciates over 27.5 years. In other words, let's say you own an investment property worth $400,000. You could depreciate $14,545.45 per year.

However, you would be on the hook for depreciation recapture. If you sell a property at a profit, the IRS wants some of the money back they allowed for depreciation. But if you sell the property at a loss, the depreciation recapture won't apply.

3. Passive Income And Pass-Through Deductions

Passive income, or income you earn with minimal effort, includes rental property earnings. If you experience losses from rental property (through depreciation, for example), you can deduct up to $25,000 in passive losses against your ordinary income as long as your modified adjusted gross income (MAGI) is $100,000 or less. Limits apply to both single or married filing jointly filers.

The deduction phases out $1 for every $2 of MAGI above $100,000 until a complete phase-out occurs at $150,000.

The pass-through deduction refers to owning rental properties as a self-proprietor or partnership (through an LLC or S-Corp). The rent you collect each month is considered qualified business income (QBI). You can deduct up to 20% of the QBI from your real estate investments.

For example, say that you collect $35,000 in rent through your rental properties during the year. You could deduct up to $7,000 on your personal tax return through the pass-through deduction and lower your taxable income.

4. Capital Gains Tax

Capital gains tax comes into play if you choose to sell your property. Capital gains tax refers to the income tax on the profit from the sale of real estate that appreciates while you own it. In other words, let's say that 5 years ago, you bought a home for $300,000 and sold it for $350,000, making a profit of $50,000. That $50,000 profit would be eligible for capital gains tax.

There are two types of capital gains taxes: Short-term capital gains and long-term capital gains. Let's take a look at both: 

  • Short-term capital gains: When you sell an investment within a year of purchase, you'll incur short-term capital gains. The tax rate you pay depends on your individual tax bracket (either the 10%, 12%, 22%, 24%, 32%, 35% or 37% bracket) and it's also based on your taxable income.
  • Long-term capital gains: The long-term capital gains tax applies if you sell real estate that you have held for over a year. Instead of following individual tax rates, long-term capital will hit either 0%, 15% or 20% (depending on your income).

Holding your investment property for longer than a year can significantly impact your tax liability. For example, let's say you're in the 24% tax bracket. You'd pay just 15% long-term capital gains tax if you held onto your investment for over a year, whereas you'd pay at your 24% individual tax bracket if you sold the investment property within that first year.

5. Tax Incentive Programs

Certain tax incentive programs can also help you save money. Let's look at a 1031 exchange, opportunity zones and tax-free or tax-deferred retirement accounts.

1031 Exchange

A 1031 exchange allows you to swap one real estate investment for another. A 1031 exchange helps you avoid both capital gains taxes and depreciation recapture – you can "kick the can down the road" – or delay capital gains taxes for years.

However, you must swap a property of equal or greater value to take advantage of a 1031 exchange.

Opportunity Zones

Similar to a 1031 exchange, opportunity zones allow you to delay paying capital gains taxes on your original investment property. You can sell a property and invest the proceeds into other properties – typically distressed rural or urban areas – located in nearly 9,000 locations across the U.S.

Tax-Free Or Tax-Deferred Retirement Accounts

Tax-free and tax-deferred retirement accounts, such as health savings accounts (HSAs) and individual retirement accounts (IRAs), allow you to add alternative assets like real estate. These often tax-deferred investments allow you to put off paying taxes until later, such as when you retire.

Depending on the account, you may face contribution limits and restrictions on the type of assets you can hold in the account.

6. Self-Employment FICA Tax

The Federal Insurance Contributions Act (FICA) contains a combination of Social Security taxes and Medicare taxes. Both employers and employees pay the same amount for each ­– 6.20% in FICA taxes and 1.45% in Medicare.

Real estate investors don't have to pay FICA taxes, unlike in the case of wages you earn for working a job (in the case of a W-2 employee).

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The Bottom Line

Real estate investor tax deductions exist, including tax write-offs for real estate investors, and that may seem very appealing as an investor. For example, you can take advantage of deductions and write-offs, depreciation, passive income and pass-through deductions, capital gains tax, tax incentive programs and exemption from the FICA tax.

Ready to buy an investment property real estate tax incentives and other perks? Start the application process to see what you can qualify for.

Melissa Brock

Melissa Brock is a freelance writer and editor who writes about higher education, trading, investing, personal finance, cryptocurrency, mortgages and insurance. Melissa also writes SEO-driven blog copy for independent educational consultants and runs her website, College Money Tips, to help families navigate the college journey. She spent 12 years in the admission office at her alma mater.