Tax Benefits of Real Estate Investing
Real estate can be a powerful way to diversify wealth while taking advantage of substantial tax benefits. Unlike other investments, real estate offers unique opportunities to reduce your taxable income and defer capital gains while benefitting from an underlying appreciating asset. In this post, we’ll explore the key tax benefits of real estate investing and learn how to leverage them to minimize your tax burden while growing your wealth.
Depreciation
Depreciation allows you to deduct the wear and tear of your property over time. For tax purposes, the IRS considers real estate a depreciable asset, and you can take a yearly deduction for a portion of the property’s value and tangible assets associated with the rental for a pre-determined period.
How depreciation works: The IRS lets you depreciate residential rental properties over 27.5 years and commercial properties over 39 years. This means you can deduct a portion of the property’s cost basis each year, lowering your taxable income. Certain tangible assets, such as appliances, wall-to-wall carpeting, new roofs, etc., can also be depreciated based on their expected life span. It is important to note that depreciation of the property may be subject to recapture once the investment is sold.
Example: Let’s say you install new wall-to-wall carpet in a house that costs $10,000. Carpet is typically depreciated over 5 years, so you can deduct $2,000 annually, which will help offset your rental income. If you are in the 32% tax bracket, you will have saved $3,200 on income tax over the 5-year depreciation period.
Mortgage interest deduction
Real estate investments are often financed with debt, and the interest paid on loans used to acquire, build, or improve rental properties can be deducted from your taxable rental income.
How it works: As a property owner, you can deduct the interest you pay on a mortgage or loan used to purchase or improve real estate from your taxable rental income. This deduction applies to both residential and commercial investment properties.
Example: While there is a limit on mortgage interest deduction for your primary home, there is no limit on rental property mortgage interest deductions in most cases. This is one reason many landlords leverage their investment real estate; offsetting rental income with the mortgage interest can significantly reduce your taxable income. If you paid $45,000 in mortgage interest and your rental income was $65,000, your taxable rental income is reduced to $20,000 by writing off the mortgage interest.
Deductible operating costs
Various operating expenses associated with owning an investment property can also be deducted from your rental income.
How it works: Property management fees, repairs and maintenance, insurance, and tenant advertising should be well documented. These are additional expenses that can help to reduce your taxable rental income.
Tax strategies for divestment of real estate investments
Long-term capital gains treatment
When you sell your real estate investment, the profits (or capital gains) are typically subject to capital gains taxes. However, properties held for over a year qualify for long-term capital gains tax rates, usually lower than regular income tax rates.
How it works: If you hold a property for more than a year before selling, you qualify for the long-term capital gains tax rate, which is generally lower than the ordinary income tax rate. Long-term capital gains rates range from 0% to 20%, depending on your income level.
Opportunity zones
Opportunity Zones were established to encourage investment in low-income and economically distressed communities. You can defer paying taxes if you invest capital gains in an Opportunity Zone. If you hold the investment for ten years, you may eliminate taxes on the appreciation of the new investment.
How opportunity zones work: If you reinvest capital gains into an Opportunity Zone Fund, you can defer paying taxes on those gains through 2026 or until you sell the investment, whichever comes first. Ten years after your initial investment in the Opportunity Zone, any gains on the new investment are tax-free.
Why it matters for you: If you’re looking for tax-advantaged investment opportunities, you can benefit from deferring taxes and potentially eliminating them through Opportunity Zones. Additionally, these investments may align with your social impact goals, providing financial and community benefits.
Example: If you invest $500k of capital gains in a Qualified Opportunity Zone in 2025, you will not recognize those gains until the 2026 tax year. Let’s say that in 10 years, that investment will appreciate $800k, a $300k gain. You will not pay taxes on that gain, and if you are in the 15% capital gains tax bracket, you will have saved $45,000 in taxes.
1031 Exchange
Utilizing a 1031 exchange strategy, you can defer paying capital gains taxes if you reinvest the proceeds from the sale into a similar property. This leaves you with more to invest and allows you to keep growing your real estate portfolio without being taxed on every sale.
How a 1031 exchange works: Under 1031 exchange rules, you sell one property and purchase another similar one (of equal or greater value) within a specific timeframe. This defers the capital gains tax until you sell the new property outright, allowing you to defer indefinitely if you continue reinvesting into another like-kind property.
Why it matters for you: By deferring capital gains taxes, you can reinvest your principal and profits into new properties and expand your portfolio without losing capital to taxes after each sale.
Example: You bought a single-family rental home for $500k, now valued at $1M. If you sold the home outright, you would pay capital gains tax on $500k (the appreciation), eroding the profits from the investment. If you performed a 1031 exchange into a $1.5M duplex, you can defer the gains until the property is sold outright.
Real estate offers a range of tax benefits that can help you grow and protect your wealth. From depreciation to 1031 exchanges, mortgage interest deductions to Opportunity Zones, and the lower tax rates on long-term capital gains, there are numerous ways to leverage real estate for wealth-building and tax minimization. By understanding and utilizing these tax strategies, you can make real estate a valuable part of your broader financial plan.
We strongly recommend you work with your financial advisor and tax expert when investing in real estate and the various exit strategies.
The information contained in this document is provided for informational purposes only and should not be construed as individualized advice. For individualized advice, please consult with your adviser. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Brighton Jones, LLC), or any non-investment related content, made reference to directly or indirectly in this advertisement will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, this content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this advertisement serves as the receipt of, or as a substitute for, personalized investment advice from Brighton Jones, LLC. To the extent that you have any questions regarding the applicability of any specific issue discussed above to your individual situation, you are encouraged to consult with a professional advisor of your choosing. Brighton Jones, LLC is neither a law firm nor a certified public accounting firm and no portion of this content should be construed as legal or accounting advice. A copy of our current written disclosure statement discussing our advisory services and fees is available on our website and on brokercheck.finra.org.
