Overview

Real estate investing creates tax opportunities and traps. Income from rentals, deductions for expenses and depreciation, capital gains when you sell, and special rules like passive activity limits or 1031 exchanges all influence your after-tax return. This guide focuses on practical, up-to-date tax basics U.S. real estate investors should understand so you can reduce tax liability, avoid costly errors, and plan transactions with tax outcomes in mind.

Core categories every investor must track

  • Rental income and expenses: Report gross rents, then subtract allowable expenses (mortgage interest, property taxes, insurance, repairs, management fees, and utilities you pay). The net is taxable rental income unless losses are allowed under passive activity rules (see below).
  • Depreciation: A non-cash deduction that spreads the building’s cost (not land) over a recovery period (residential rental: 27.5 years; commercial: 39 years). Use Form 4562 to report depreciation (IRS) (see Form 4562 guidance).
  • Basis and adjusted basis: Your tax basis starts with purchase price plus acquisition costs. Basis is adjusted up for improvements and down for depreciation. Basis determines gain or loss on sale and allowable depreciation deductions (IRS Publication 551).
  • Capital gains vs ordinary income: Gains on sales held over one year qualify for long-term capital gains rates; short-term gains are taxed at ordinary rates. Depreciation recapture for real property often results in a separate tax treatment (see Depreciation Recapture discussion and IRS guidance).

Depreciation in practice

Depreciation reduces taxable rental income each year and lowers your adjusted basis in the property. For most residential rental property you’ll use straight-line depreciation over 27.5 years. Be sure to: keep a depreciation schedule, claim depreciation on time, and understand that depreciation claimed now may cause “recapture” tax when you sell.

For detailed mechanics and recordkeeping, refer to our in-depth depreciation article and IRS Publication 946 (How to Depreciate Property) (IRS Publication 946: https://www.irs.gov/forms-pubs/about-publication-946). If you need help fixing or amending depreciation claims, see our guidance on amending returns for depreciation errors and related articles such as [Depreciation](