Seven Tax Benefits of Owning Rental Property

Investing in rental properties is one of the easiest ways to diversify your real estate portfolio. These properties can generate consistent passive income and have the potential for long-term appreciation. It’s also a more stable form of investment than stocks or bonds, which have been proven to be highly volatile.

More importantly, rental properties come with several tax benefits. These major advantages can help you reduce your tax liabilities and increase your overall return on investment. These deductions, pass-through taxation, and other perks will help you keep more of your hard-earned earnings.

What are the Tax Benefits of Owning Rental Property?

There are seven tax benefits to owning rental properties. These are the following:

Operating Expenses Deductions

As a rental property owner, you can deduct your expenses for managing and maintaining rental properties from your taxable income. This deduction is one of the major tax benefits of owning rental properties. According to the IRS, you can deduct the following from your tax returns:

• Repairs and maintenance costs.
• Utilities and homeowner’s association fees.
• Property management fees.
• Property taxes.
• Homeowner/landlord liability insurance.
• Legal and professional fees.

While these write-offs can significantly reduce your taxes, it’s crucial to keep detailed records of your expenses. This will ensure you can claim them and have supporting documents ready in case of an IRS audit.

Mortgage Interest Deductions

Aside from your operating expenses, you can deduct mortgage interest from your taxes. If you took out a loan to finance your rental property, the interest you’re paying is considered tax-deductible. You can claim this write-off using the IRS Form 1098, which you can get from your lender.

Depreciation Deduction

Your rental property’s value will depreciate over time, but the good news is depreciation is a tax-deductible expense. The IRS allows real estate investors to deduct a portion of the property’s cost over its useful life.

Currently, the designated useful life for residential rental properties is 27.5 years, while for commercial rental properties, the period is 39 years.

You can calculate your deduction by dividing your rental property’s current value by its useful life. So, if your rental home is valued at $300,000, you can deduct up to $10,909 in yearly depreciation.

If you decide to sell your rental property later on, you’ll need to pay taxes on the depreciation deductions you’ve claimed. This is known as depreciation recapture. While the tax rate for this is typically higher than that for capital gains, there are effective strategies to avoid it, which we’ll discuss in detail later on. 

Pass-through Deductions

Pass-through deduction is another excellent tax benefit to owning rental properties. If you’ve purchased rental properties through pass-through entities like real estate LLCs or partnerships, you deduct up to 20% of your qualified business income (QBI) from your tax returns.

This deduction is part of the Tax Cuts and Jobs Act 2017 and will expire on December 31, 2025. So, if you’re yet to claim this write-off, now’s the right time to do it.

Capital Gains

Capital gains refer to the profit you yield when you sell a property. These earnings are typically taxed, but their rates vary depending on which type of gain you realize.

There are two primary types of capital gains: short-term and long-term. Short-term gains are yielded when you sell properties you’ve owned for less than a year, while long-term gains are realized when you sell properties you’ve owned for more than a year.

Short-term gains typically have higher tax rates than long-term gains because they’re considered ordinary income. These rates range from as low as 10% to as high as 37%, meaning selling your apartment complex before its first anniversary will lead to higher tax liabilities.

Conversely, holding onto properties for longer can significantly reduce your tax burdens. The tax rate for long-term gains is only 0% to 20%, meaning you can keep more of your profits if you time the sale of your rental properties carefully.

Tax-deferred Investment Strategies

As mentioned earlier, there are ways to defer capital gain taxes and it involves two different TCJA programs: the 1031 Exchange and Opportunity Zone program.

Under the 1031 Exchange program, you can defer paying taxes on the capital gains you realized from selling your rental property if you reinvest it into another qualified property.

Meanwhile, you can defer your capital gain taxes in the Opportunity Zone Program by investing in Qualified Opportunity Funds designated for improving low-income areas or opportunity zones.

The mechanics of these two programs are relatively complicated, so we suggest consulting a tax professional before proceeding.

FICA Tax-break

If you’re self-employed, you must pay the FICA or payroll tax. This tax is typically divided between employees and employers, but since you assume both roles, you must pay the entire 15.3% rate yourself.

Fortunately, rental income is generally not subject to FICA taxes. It will only be subjected to payroll tax if the IRS considers it earned income.

Other Tax Saving Strategies For Rental Property Owners

In addition to the seven tax benefits we’ve discussed, you can employ other strategies to reduce your tax burden, such as forming a real estate limited liability company (LLC).

A real estate LLC will give you pass-through tax status, crucial to avoiding double taxation and major write-offs like the QBI tax deduction.

More importantly, real estate LLCs will provide you with asset protection. Since LLCs are considered legal entities separate from their owners, they will be responsible for any debt and other financial liabilities the business incurs.

For instance, if your real estate LLC defaults on a loan it took for a rental property, creditors can only go after the company’s assets, not yours. This type of protection is crucial in a high-risk, high-reward venture such as real estate investing.

Owning rental properties comes with risks, so protecting your hard-earned assets from potential dangers is best.

Maximize Your Profits & Minimize Your Taxes

Investing in rental properties offers more than a steady stream of passive income; it also opens the door to major tax benefits that can significantly lower one’s taxes. From major deductions to tax-deferred programs, these perks will help you maximize your profits and minimize your taxes.

For an added perk of asset protection, consider forming a real estate LLC with NCH’s help.

NCH is committed to helping investors like you form LLCs for real estate investing. Our team of business specialists will help you structure your LLC so that you get maximum liability protection and lower tax liabilities.

To learn more, visit our website here or call us at 1-800-508-1729 to schedule a free consultation with one of our business formation specialists.

Disclaimer: The above material has been prepared for informational purposes only, containing opinions of the provider, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.

Investing in rental properties is one of the easiest ways to diversify your real estate portfolio. These properties can generate consistent passive income and have the potential for long-term appreciation. It’s also a more stable form of investment than stocks or bonds, which have been proven to be highly volatile.

More importantly, rental properties come with several tax benefits. These major advantages can help you reduce your tax liabilities and increase your overall return on investment. These deductions, pass-through taxation, and other perks will help you keep more of your hard-earned earnings.

What are the Tax Benefits of Owning Rental Property?

There are seven tax benefits to owning rental properties. These are the following:

Operating Expenses Deductions

As a rental property owner, you can deduct your expenses for managing and maintaining rental properties from your taxable income. This deduction is one of the major tax benefits of owning rental properties. According to the IRS, you can deduct the following from your tax returns:

• Repairs and maintenance costs.
• Utilities and homeowner’s association fees.
• Property management fees.
• Property taxes.
• Homeowner/landlord liability insurance.
• Legal and professional fees.

While these write-offs can significantly reduce your taxes, it’s crucial to keep detailed records of your expenses. This will ensure you can claim them and have supporting documents ready in case of an IRS audit.

Mortgage Interest Deductions

Aside from your operating expenses, you can deduct mortgage interest from your taxes. If you took out a loan to finance your rental property, the interest you’re paying is considered tax-deductible. You can claim this write-off using the IRS Form 1098, which you can get from your lender.

Depreciation Deduction

Your rental property’s value will depreciate over time, but the good news is depreciation is a tax-deductible expense. The IRS allows real estate investors to deduct a portion of the property’s cost over its useful life.

Currently, the designated useful life for residential rental properties is 27.5 years, while for commercial rental properties, the period is 39 years.

You can calculate your deduction by dividing your rental property’s current value by its useful life. So, if your rental home is valued at $300,000, you can deduct up to $10,909 in yearly depreciation.

If you decide to sell your rental property later on, you’ll need to pay taxes on the depreciation deductions you’ve claimed. This is known as depreciation recapture. While the tax rate for this is typically higher than that for capital gains, there are effective strategies to avoid it, which we’ll discuss in detail later on. 

Pass-through Deductions

Pass-through deduction is another excellent tax benefit to owning rental properties. If you’ve purchased rental properties through pass-through entities like real estate LLCs or partnerships, you deduct up to 20% of your qualified business income (QBI) from your tax returns.

This deduction is part of the Tax Cuts and Jobs Act 2017 and will expire on December 31, 2025. So, if you’re yet to claim this write-off, now’s the right time to do it.

Capital Gains

Capital gains refer to the profit you yield when you sell a property. These earnings are typically taxed, but their rates vary depending on which type of gain you realize.

There are two primary types of capital gains: short-term and long-term. Short-term gains are yielded when you sell properties you’ve owned for less than a year, while long-term gains are realized when you sell properties you’ve owned for more than a year.

Short-term gains typically have higher tax rates than long-term gains because they’re considered ordinary income. These rates range from as low as 10% to as high as 37%, meaning selling your apartment complex before its first anniversary will lead to higher tax liabilities.

Conversely, holding onto properties for longer can significantly reduce your tax burdens. The tax rate for long-term gains is only 0% to 20%, meaning you can keep more of your profits if you time the sale of your rental properties carefully.

Tax-deferred Investment Strategies

As mentioned earlier, there are ways to defer capital gain taxes and it involves two different TCJA programs: the 1031 Exchange and Opportunity Zone program.

Under the 1031 Exchange program, you can defer paying taxes on the capital gains you realized from selling your rental property if you reinvest it into another qualified property.

Meanwhile, you can defer your capital gain taxes in the Opportunity Zone Program by investing in Qualified Opportunity Funds designated for improving low-income areas or opportunity zones.

The mechanics of these two programs are relatively complicated, so we suggest consulting a tax professional before proceeding.

FICA Tax-break

If you’re self-employed, you must pay the FICA or payroll tax. This tax is typically divided between employees and employers, but since you assume both roles, you must pay the entire 15.3% rate yourself.

Fortunately, rental income is generally not subject to FICA taxes. It will only be subjected to payroll tax if the IRS considers it earned income.

Other Tax Saving Strategies For Rental Property Owners

In addition to the seven tax benefits we’ve discussed, you can employ other strategies to reduce your tax burden, such as forming a real estate limited liability company (LLC).

A real estate LLC will give you pass-through tax status, crucial to avoiding double taxation and major write-offs like the QBI tax deduction.

More importantly, real estate LLCs will provide you with asset protection. Since LLCs are considered legal entities separate from their owners, they will be responsible for any debt and other financial liabilities the business incurs.

For instance, if your real estate LLC defaults on a loan it took for a rental property, creditors can only go after the company’s assets, not yours. This type of protection is crucial in a high-risk, high-reward venture such as real estate investing.

Owning rental properties comes with risks, so protecting your hard-earned assets from potential dangers is best.

Maximize Your Profits & Minimize Your Taxes

Investing in rental properties offers more than a steady stream of passive income; it also opens the door to major tax benefits that can significantly lower one’s taxes. From major deductions to tax-deferred programs, these perks will help you maximize your profits and minimize your taxes.

For an added perk of asset protection, consider forming a real estate LLC with NCH’s help.

NCH is committed to helping investors like you form LLCs for real estate investing. Our team of business specialists will help you structure your LLC so that you get maximum liability protection and lower tax liabilities.

To learn more, visit our website here or call us at 1-800-508-1729 to schedule a free consultation with one of our business formation specialists.

Disclaimer: The above material has been prepared for informational purposes only, containing opinions of the provider, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.