Tax Implications of Owning Rental Property

Owning rental property can provide steady income and long-term growth, but it also comes with specific tax rules that are different from personal home ownership.

This article explains the main tax implications of owning rental property, including how rental income is taxed, what expenses may be deductible, and what to watch for over time.

🟢 HOW RENTAL INCOME IS TAXED

Rental income is generally taxable income and must be reported on your tax return.

Rental income includes:

🔹 Monthly rent payments

🔹 Advance rent

🔹 Payments for lease cancellations

🔹 Tenant-paid expenses on your behalf

Rental income is reported even if you did not receive a tax form.

🟢 DEDUCTIBLE RENTAL EXPENSES

Many costs associated with owning rental property may be deductible.

Common deductible expenses include:

🔹 Mortgage interest

🔹 Property taxes

🔹 Insurance

🔹 Repairs and maintenance

🔹 Property management fees

🔹 Utilities paid by the owner

🔹 HOA dues

🔹 Advertising and legal fees

Only expenses related to the rental portion of the property are deductible.

🟢 DEPRECIATION (A KEY TAX BENEFIT)

Depreciation allows you to deduct the cost of the property over time, even if the property is increasing in value.

Key points about depreciation:

🔹 Residential rental property is depreciated over 27.5 years

🔹 Only the building (not the land) is depreciated

🔹 Depreciation can reduce taxable rental income

Depreciation is often one of the largest tax benefits of owning rental property.

🟢 PASSIVE ACTIVITY RULES

Rental income is usually considered passive income.

This affects:

🔹 Whether rental losses can offset other income

🔹 How losses are carried forward

Some owners may qualify for exceptions, such as:

🔹 Active participation allowances

🔹 Real estate professional status

These rules depend on income level and involvement.

🟢 PERSONAL USE VS. RENTAL USE

Tax treatment changes if a property is used both personally and as a rental.

Important considerations:

🔹 Expenses must be allocated between personal and rental use

🔹 Deduction limits may apply

🔹 Vacation and short-term rentals have special rules

Mixing personal and rental use requires careful tracking.

🟢 SELLING A RENTAL PROPERTY

Selling a rental property can trigger several types of tax.

Potential taxes include:

🔹 Capital gains tax on appreciation

🔹 Depreciation recapture on prior depreciation

🔹 State income tax

The longer a property is held and depreciated, the more important planning becomes before selling.

🟢 1031 EXCHANGES AND RENTAL PROPERTY

Some rental property owners use a 1031 exchange to defer taxes when selling.

A 1031 exchange allows:

🔹 Deferral of capital gains tax

🔹 Deferral of depreciation recapture

🔹 Reinvestment into another qualifying rental or investment property

Strict timelines and rules apply.

🟢 COMMON RENTAL PROPERTY TAX MISTAKES

🔹 Not reporting all rental income

🔹 Missing deductible expenses

🔹 Failing to depreciate the property

🔹 Mixing personal and rental expenses

🔹 Not planning for taxes before selling

Most issues arise from lack of planning rather than errors.

🟢 A PRACTICAL RULE OF THUMB

🔹 Rental income → generally taxable

🔹 Rental expenses → often deductible

🔹 Depreciation → reduces current taxes but affects future sales

🔹 Selling property → plan ahead for taxes

Rental property taxes work best when viewed long-term.

🟢 NEED HELP WITH RENTAL PROPERTY TAXES?

Rental property taxes involve income reporting, deductions, depreciation, and exit planning.

At Pacific Change, we help property owners:

🔹 Report rental income correctly

🔹 Maximize allowable deductions

🔹 Apply depreciation properly

🔹 Plan for future property sales

🔹 Coordinate rental income with overall tax strategy

If you own rental property and want clarity on the tax implications, we’re happy to help.