Taxes can be a touchy subject, but as real estate investors, there’s a lot to be happy about when it comes to tax time.
Let’s take a look at some of the tax advantages that real estate investments deliver. While no one gets super-excited about filing their taxes and paying what they owe, the rental properties you own can be a great way to limit your annual tax liability.
Depreciation as a Deduction
One of the most significant tax benefits for real estate investors is depreciation. The IRS allows investors to deduct the cost of the investment property over time as it depreciates. Depreciation can be deducted over 27.5 years for residential properties.
The best part? Depreciation is a non-cash expense, meaning you don’t need to actually spend money for this deduction. It reduces your taxable income, potentially lowering your overall tax exposure. In some cases, depreciation can offset a substantial portion of your rental income, meaning you could receive rental income and still pay little to no taxes on it.
Why We Like 1031 Exchanges
You can defer the taxes you’d have to pay on a property you sell.
This is another significant tax strategy available to real estate investors: the 1031 Exchange. This provision allows you to defer paying capital gains taxes when you sell a property, provided you reinvest the proceeds into a similar property of equal or greater value. The idea is that by continually reinvesting, you can defer the taxes indefinitely.
The 1031 Exchange is an incredibly valuable strategy for those looking to scale their portfolios. While the tax isn’t eliminated, it’s postponed until you eventually sell without replacing the property.
Mortgage Interest Deductions
Real estate investors who finance their properties with mortgages can deduct mortgage interest from their taxable income. Whether you’re borrowing to purchase a rental property or to refinance one, the interest you pay on the loan is tax-deductible.
This deduction can significantly reduce your taxable income, especially in the early years of a mortgage when a large portion of your payment goes toward interest.
Let’s say, for example, you have a mortgage on an investment property for $500,000 at an interest rate of 4%. This may mean you can deduct around $20,000 in interest payments during the first year. This deduction helps lower your overall tax bill and improves your cash flow from the property.
Operating Expenses: Deducting Costs of Leasing and Property Management
As a real estate investor, you’re likely to incur various expenses in leasing and managing your properties. The good news is that many of these costs are tax-deductible. Common deductible operating expenses include:
- Property management fees
- Maintenance and repairs
- Utilities
- Insurance premiums
- Advertising costs
These expenses are deducted from your rental income, which reduces the amount of taxable income you report. The more you can deduct in operating costs, the less tax you’ll pay on your investment income. We’re always reminding investors that professional property management services essentially pay for themselves thanks to their ability to write off the management fees and leasing fees that they pay.
Maintenance is an operating expense but improvements are not. If you spend $10,000 on maintenance and repairs for a rental property during the year, that $10,000 can be deducted from your rental income, thus lowering your taxable income for the year. If you upgrade your kitchen, though, or renovate a bathroom, those would not be considered tax-deductible repairs.
Capital Gains Tax Rates
When you sell a real estate investment, you may be subject to capital gains taxes on the profit you made from the sale. However, if you hold the property for over a year, the gains are classified as long-term capital gains, which are taxed at a lower rate than short-term gains (typically lower than your ordinary income tax rate).
In 2025, long-term capital gains are taxed at a maximum rate of 15% or 20%, depending on your income level, while short-term gains are taxed as ordinary income, potentially subject to rates as high as 37%. This makes long-term real estate investment an attractive way to minimize your tax burden.
Qualified Business Income (QBI) Deduction for Active Investors
If you are an active investor—meaning you materially participate in the management and operation of your properties—you may qualify for the Qualified Business Income (QBI) deduction. This deduction allows investors to deduct up to 20% of their qualified rental income.
To qualify, you need to meet specific criteria set by the IRS, including regular involvement in the day-to-day operations of your real estate business, which might include managing tenants, repairs, and leasing. If you qualify, the QBI deduction can further reduce your taxable income.
Tax Benefits for Real Estate Investment Trusts (REITs)
If you’re looking to invest in real estate without the direct responsibility of property ownership and management, investing in Real Estate Investment Trusts (REITs) may be an appealing option. REITs are companies that own or finance income-producing real estate and are required by law to distribute at least 90% of their taxable income to shareholders in the form of dividends.
While REITs don’t offer the same level of tax advantages as direct property ownership, they do offer a variety of tax benefits, including:
- Dividend deductions. REITs pay out income as dividends, which may be subject to preferential tax treatment depending on the investor’s situation.
- Diversification and liquidity. Unlike owning physical real estate, REITs offer the flexibility of being traded on the stock market, offering greater liquidity and diversification within your portfolio.
Real estate offers a range of tax advantages that can significantly boost your investment returns and minimize your risk. By leveraging depreciation, taking advantage of tax-deferred strategies like 1031 exchanges, and utilizing mortgage interest and operating expense deductions, real estate investors can reduce their taxable income and increase cash flow.
We’re providing this advice as your property management partner. Always consult with a tax professional or financial advisor to ensure that you’re making the most of the tax advantages available to you.
Please contact us at South County Property Management with any questions about the tax benefits of real estate investments. We work with investors all over Santa Clara County, including San Jose, Campbell, Saratoga, Cupertino, Sunnyvale, Los Gatos, Milpitas, Morgan Hill, Gilroy, and neighboring areas.
