Real Estate Tax Strategies for Landlords: Depreciation, REPS, and More

The key to success as a real estate investor lies in the mastery of real estate tax deductions and the implementation of long-term tax strategies. Done right this can dramatically reduce your overall rental income tax liability while ensuring your remain compliant with stringent IRS rules and regulations.

There are several effective rental property tax strategies at the disposal of real estate investors. For example, leveraging depreciation on real estate and taking advantage of Real Estate Professional Status (REPS) and Qualified Business Income (QBI) deductions.

In this article, we explore valuable real estate tax strategies that you can implement immediately to lower your upcoming tax bill and enhance your annual revenue. Additionally, we introduce how you can use software like Landlord Studio to streamline the tax filing process, maximize your deductions, and minimize your overall tax liability.

Depreciation: Maximizing Tax Benefits Over Time

One of the most effective strategies landlords can use to reduce their taxable income under the IRS provisions is the effective use of depreciation. Depreciation allows investors to deduct the value of an asset against their taxable income over time - the aim is to reflect the wear and tear associated with its use. 

When it comes to real estate landlords and investors can actually depreciate the value of the property itself (minus the value of the land). The IRS specifies the standard depreciation period for residential properties is 27.5 years while commercial properties have a longer period of 39 years.

For example, if a residential property is purchased for $550,000 with a landlord value of $150,000, the annual depreciation deduction would be approximately $14,545 a year ($400,000 divided by 27.5 years). This is a non-cash expense (eg. there is no actual cash expenditure), meaning this deduction is hugely powerful when it comes to increasing rental property profitability.

Also read: Understanding Rental Property Depreciation and Depreciation Recapture

Eligible Assets for Depreciation

Landlords should note that not all assets associated with a rental property can be depreciated. According to the IRS, here are some of the key categories that are eligible:

• Buildings: The primary structure itself can be depreciated over its useful life.
• Capital Improvements (CAPEX): These include substantial upgrades or renovations such as kitchen remodels or new roofs.
• Appliances: Items like refrigerators, stoves, and washing machines can be depreciated, typically over a shorter schedule of 5 to 7 years.
• Furnaces: These are generally depreciated along with the building.
• Leasehold Improvements: Significant changes made to the property for tenant use can also be depreciated.
• Landscaping Improvements: Enhancements made to the exterior landscape are eligible for depreciation.
• Equipment: Tools and machinery used for property maintenance, such as lawn mowers or cleaning equipment.

It's important to note that land itself is not a depreciable asset; thus, no deductions can be claimed on its value. Additionally, repair costs and service contracts cannot be depreciated but can be deducted as regular expenses from net income.

Passive Activity Loss (PAL) Rules

The IRS has specific regulations that govern how losses from passive activities, primarily rental real estate, can be treated for tax purposes. These rules are designed to prevent taxpayers from using passive losses to offset ordinary income unless they meet specific criteria.

According to the Passive Activity Loss (PAL) rules, losses from passive activities can only be used to offset income from other passive activities, such as rental income. This means that landlords cannot apply passive losses to their ordinary income, such as wages or business income unless they qualify for certain exceptions.

To claim losses against passive income, a taxpayer must demonstrate material participation in the rental activity. Material participation involves being regularly involved in the operations of the business. If a taxpayer does not materially participate, their rental activity is classified as "per se passive," and they cannot offset active income with these losses.

Also read: Passive Activity and Passive Activity Loss Limitations in Real Estate

Exceptions for Landlords

Despite the stringent nature of the PAL rules, some exceptions allow landlords to offset their ordinary income with rental losses:

• $25,000 Allowance: Landlords who actively participate in their rental activities may deduct up to $25,000 of passive rental losses against non-passive income. However, this allowance phases out for individuals with a modified adjusted gross income (MAGI) exceeding $100,000 and is completely eliminated at a MAGI of $150,000.
• Real Estate Professional Exemption: If a taxpayer qualifies as a real estate professional—defined by meeting specific participation criteria—they can treat all rental losses as active and deduct them against other income without limitation. This status requires participation in real estate activities for over 750 hours in a year or meeting other substantial involvement criteria.

Learn more about Real Estate Professional Status (REPS) and how to qualify here.

Implications for Landlords

For many landlords, especially those with lower incomes or those just starting out, the PAL rules can create challenges in utilizing their rental losses effectively. 

If a landlord's rental expenses exceed their rental income but they do not meet the criteria for active participation or exceed the MAGI thresholds, their losses may become "suspended." These suspended losses, however, can be carried forward to future tax years when there is sufficient passive income to absorb them or when the property is sold in a fully taxable transaction.

Real Estate Professional Status (REPS) & Qualified Business Income Deduction (QBI)

Real Estate Professional Status (REPS) and the Qualified Business Income (QBI) deduction are two significant tax provisions that can provide substantial savings for individuals engaged in real estate activities. That's why landlords need to understand the eligibility criteria for these statuses and their associated benefits.

Criteria for Real Estate Professional Status (REPS)

To qualify as a real estate professional under IRS guidelines, an individual must meet two primary requirements:

• Time Commitment: More than 50% of the personal services performed in all trades or businesses during the tax year must be dedicated to real property trades or businesses in which the individual materially participates.
• Service Hours: The individual must perform at least 750 hours of services during the tax year in real property trades or businesses where they materially participate.

Benefits of REPS

Achieving REPS status allows individuals to:

• Deduct Rental Losses: Unlike standard investors, real estate professionals can deduct rental losses against other forms of income, significantly lowering taxable income.
• Accelerated Depreciation: Real estate professionals can take advantage of accelerated depreciation methods, further reducing taxable income.
• Avoidance of Net Investment Income Tax: REPS may help avoid the 3.8% Net Investment Income Tax (NIIT), which applies to certain high-income earners.
• Long-Term Capital Gains Treatment: When selling rental properties, individuals with REPS may benefit from favorable long-term capital gains treatment. 

Eligibility for QBI Deduction

To qualify for the QBI deduction:

• The income must be derived from a qualified trade or business.
• The taxpayer must not be earning income through a C corporation or as an employee.

The QBI deduction consists of two components:

• QBI Component: This equals 20% of QBI from domestic businesses operated as sole proprietorships or through pass-through entities. It is subject to limitations based on taxable income and other factors.
• REIT/PTP Component: This equals 20% of qualified Real Estate Investment Trust (REIT) dividends and qualified publicly traded partnership (PTP) income. This component is not limited by W-2 wages or the unadjusted basis immediately after acquisition (UBIA) of qualified property.

Additional Tax Savings

Both REPS and the QBI deduction can create additional tax savings by allowing individuals to offset non-passive income with real estate losses and providing a significant reduction in taxable income through the QBI deduction. 

For instance, a real estate professional who incurs losses from rental properties can apply those losses against their overall income, leading to substantial tax savings—potentially thousands of dollars annually.

Utilizing IRS Safe Harbors to Maximize Deductions

Another way for landlords to significantly reduce their tax liabilities is by leveraging specific IRS safe harbors. These safe harbors are designed to simplify deductions related to rental properties. 

Here are three key safe harbors provided by the IRS that can benefit landlords:

1. De Minimis Safe Harbor (DMSH)

The De Minimis Safe Harbor allows landlords to deduct expenses for tangible property that do not exceed $2,500 per invoice ($5,000 if applicable financial statements are available). This safe harbor eliminates the need to capitalize and depreciate these costs, streamlining tax record-keeping and reducing administrative burdens. 

It is essential to itemize invoices, as the limit applies to each item rather than the total invoice amount. However, landlords must avoid breaking down larger expenses into smaller parts to qualify for this deduction.

2. Routine Maintenance Safe Harbor

The Routine Maintenance Safe Harbor permits landlords to deduct expenses related to routine maintenance without any annual dollar limits. Routine maintenance includes regular tasks necessary to keep a property operational, such as inspections and minor repairs. However, the costs must not improve the property’s value or extend its useful life beyond what was originally intended. 

Landlords should also adhere to the "10-year rule," which states that replacements must be expected to occur again within ten years for them to qualify as routine maintenance34.

3. Safe Harbor for Small Taxpayers (SHST)

The Safe Harbor for Small Taxpayers (SHST) allows landlords with a rental property’s unadjusted basis of less than $1 million and annual expenses not exceeding $10,000 (or 2% of the building’s unadjusted basis) to deduct all repair and maintenance costs directly on Schedule E. 

This safe harbor simplifies tax reporting by eliminating the need to differentiate between repairs and improvements, provided landlords keep detailed records of their expenses36.

Landlord Studio & Advanced Tax Strategies

Landlord Studio is a powerful accounting and reporting tool for landlords seeking to maximize advanced tax strategies like Real Estate Professional Status (REPS) and Qualified Business Income (QBI) deductions. The platform enables users to accurately track time spent on property management activities, which is essential for substantiating REPS claims.

With automated expense categorization, landlords can easily identify tax deductible costs, ensuring compliance with IRS requirements. Additionally, Landlord Studio generates property-specific reports that simplify tax preparation and help maintain organized records, crucial for tax audits.

Create a free account with Landlord Studio today to streamline income and expense tracking and make tax filing a breeze.