Introduction

One of the biggest tax benefits of Tax benefits of owning investment property is the ability to deduct depreciation expenses on your annual tax return. Depreciation allows you to deduct the cost of the building itself over a period of 27.5 years for residential property and 39 years for commercial property. You can deduct depreciation even if the property value appreciates over time.

Depreciation Deductions

The IRS permits investors to deduct depreciation based on the following schedule:

• Year 1: 3.636% depreciation
• Years 2-27: 3.637% annual depreciation
• Years 28-39: 1. 276% annual depreciation (commercial property only)

In addition, you can deduct the cost of improvements made to the property like upgrading appliances, flooring, or the HVAC system. These improvements are depreciated over 5 or 15 years.

Maximizing your depreciation deductions in the early years of property ownership allows you to shelter more rental income from taxes. You can use a cost segregation study to identify components of the building that qualify for faster depreciation too.

Expense Deductions

Owning and operating a rental property leads to many expenses that you can deduct on your annual tax return. Common expense deductions for Tax benefits of owning investment property include:

• Property management fees
• Repairs and maintenance
• Utilities
• Property taxes
• Insurance
• Mortgage interest
• Advertising costs for finding tenants
• Legal and professional fees

Tracking all your rental expenses carefully throughout the year makes tax filing easier. Good record keeping helps document these expenses if ever audited by the IRS.

Cost Basis & Capital Gains

When you eventually sell an investment property, your tax liability depends heavily on your cost basis and capital gains.

Your cost basis is the original price you paid for the property plus capital improvements made over the years. This cost basis gets depreciated over the life of the rental. Any depreciation you deducted previously gets recaptured and taxed as ordinary income when you sell.

The difference between the net selling price and your adjusted cost basis is counted as capital gains. You pay preferential tax rates on capital gains (15% for most taxpayers) versus ordinary income rates up to 37%.

Living in the property for 2 out of the last 5 years also makes you eligible for the $250,000 capital gains tax exemption as a single filer.

1031 Exchanges

Selling one Tax benefits of owning investment property and wanting to purchase another? With a 1031 exchange you can defer paying capital gains taxes by reinvesting in a new rental property. Requirements include:

• Buying a similar value property
• Completing the exchange within 180 days
• Identifying the new property within 45 days
• Using a qualified intermediary to facilitate the transaction

As long as you remain invested in real estate, you can continue deferring taxes on capital gains through 1031 exchanges.

Tax Reform Effects

Recent tax reform legislation has affected certain tax benefits of owning investment property:

• The Tax Cuts and Jobs Act limited mortgage interest deductions to loans up to $750,000 (down from $1 million)
• State and local tax deductions are now capped at $10,000 annually
• The depreciation bonus allowance providing faster write-offs was temporarily increased

Consult with a savvy tax professional to maximize the tax incentives available to you as a rental property owner. Stay up-to-date on any policy changes that may impact your benefits.

Also Read:

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Additional Tax Tips

• Purchase properties in opportunity zones for added tax incentives
• Keep accurate records separating rental and personal expenses
• Contribute to a retirement fund like a Solo 401k to lower taxable income
• Deduct travel expenses for visiting your rental properties
• Bundle repairs and maintenance itemized deductions in alternate years
• Take the standard deduction when more beneficial tax-wise
• Expense system upgrades under Section 179 to speed up depreciation

With proper planning, the tax incentives associated with Tax benefits of owning investment property ownership can significantly enhance your bottom line. Deductions reduce taxable rental income while deferred capital gains provide powerful wealth building leverage over time. Partnering with a knowledgeable tax professional and accountant ensures you fully leverage the available tax benefits.

References

• IRS Publication 527 – Residential Rental Property https://www.irs.gov/publications/p527
• Investopedia – Tax Benefits of Owning Rental Property