Many high earners want to hang on to more of their money and cut down their tax bills. You can legally pay little to no taxes on rental income by using common tax deductions, reporting all expenses, and taking advantage of property depreciation.
*Quick heads-up: I’m a dentist, not a CPA—so don’t take this as tax advice. Always check with a qualified tax pro before making any moves. Want to work with the same CPA firm I use? You can connect with them HERE.
If you know how the tax code works, you could save thousands every year.
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What Qualifies as Rental Income
Rental income isn’t just the monthly rent. It includes any payment tenants make for using your property—advance rent, security deposits you keep, even the value of improvements tenants make instead of paying rent.
Late fees, lease cancellation fees, and payments for utilities (if they’re not already in the rent) count as taxable rental income too. You need to report all these payments each year—even if you never actually see the cash.
The Internal Revenue Service (IRS) spells out what you must report in its guidelines. Keeping good records helps a lot. Jot down all amounts you receive and save documents like lease agreements or bank statements that show your rental activity.
Rental Income vs. Regular Income
Rental income is usually considered passive income, unless you’re running a rental business or offering extra services. It’s not taxed like salary or freelance income, so different tax laws apply.
Related: How To Invest 100k In Real Estate For Passive Income
Understanding how the IRS treats rental real estate helps you avoid costly mistakes. Rental property owners must keep clear records of gross income, expenses, and taxable rental income.
Legal Strategies to Minimize or Eliminate Taxes on Rental Income
Maximizing Depreciation and Deductions
Depreciation deductions are a powerful way to lower your tax bill. The IRS lets you deduct part of your residential rental property’s value each year (over a 27.5-year useful life).
Even though the property’s value might be going up, you still get the write-off.
You can also deduct:
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Property taxes
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Mortgage interest
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Repairs
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Insurance
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Property management fees
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Maintenance costs
These tax deductions reduce your taxable income and tax liabilities. Passive activity loss limitations may apply if expenses exceed your rental income, but you may still offset other passive income.
Join the Passive Investors Circle
Using Self-Directed IRAs and Retirement Accounts
A self-directed IRA lets you hold real estate investments in a retirement account. When you buy investment property with a self-directed IRA, any rental income usually grows tax-deferred or even tax-free, depending on the account type.
This means you won’t pay taxes on passive income or capital gains until you withdraw the money—often at retirement, when your income and tax rate might be lower. Strict IRS rules apply, especially about prohibited transactions and property use.
Work with a knowledgeable custodian who understands these accounts and follows all the tax rules.
Take Advantage of the 1031 Exchange
A 1031 exchange lets you sell one investment property and buy another without paying capital gains taxes, as long as you follow the rules:
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Use a qualified intermediary.
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Identify a new property within 45 days.
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Close on the replacement within 180 days.
This method delays your tax burden and gives you more buying power to grow your portfolio.
Related: 1031 Exchange Rules: What Real Estate Investors Must Know
Form a Limited Liability Company (LLC)
Owning property through an LLC can provide tax advantages and legal protection. An LLC may allow for more deductible expenses, and income passes through to your personal return to avoid double taxation.
Check state laws, as some have annual fees or added requirements.
Tax Deductions Every Rental Property Owner Should Know
Rental expenses reduce your net rental income. Common deductible expenses include:
To qualify, expenses must be necessary and related to rental activity.
Mortgage Interest Deductions
You can deduct interest paid on a mortgage used to buy or improve your rental property. Principal payments are not deductible.
Refinancing? Interest on those loans may also be deductible if used for the property.
Property Taxes and Assessments
Property taxes are a major deduction. But not all assessments qualify. If the assessment improves the property’s value (like adding sidewalks), it may not be deductible that year and could need to be depreciated instead.
Reporting Rental Income and Deductions Correctly
The IRS requires you to report your rental income and expenses properly. Good records can lower your tax bill and help you avoid headaches later.
Using IRS Forms and Schedule E
You have to report all rental income on your federal tax return every year. Most landlords use Schedule E (Form 1040) to report income and claim deductions for each property.
This form asks for details about each property, total income received, and itemized expenses like mortgage interest, property taxes, repairs, and insurance. Schedule E covers both gross rental receipts and the deductions you claim.
Use the correct tax year, especially if a lease started or ended partway through the year. Mistakes or skipping Schedule E can trigger IRS scrutiny.
Tracking Gross and Net Rental Income
It’s important to know the difference between gross income and net rental income.
Gross Income
Gross income is all the money you get from tenants during the year, before deducting any expenses—rent, late fees, or fees for extra services in the lease.
Net income
Net rental income is what’s left after you subtract allowed expenses from your gross income. Allowed expenses could be advertising, repairs, utilities you paid, or management fees.
Handling Security Deposits and Lease Terms
Don’t count security deposits as rental income if you plan to return them at the end of the lease. If you keep any part of the deposit for unpaid rent or repairs, you’ll need to report that amount as income for the year you use it.
Lease terms can affect when you report income. Advance rent might need to be counted the year you receive it, even if it’s for next year. If you live in the property part of the time, you’ll have to split deductions between personal and rental use.
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Advanced Planning Tips for Lower Taxes
Keep Great Records
Track everything—income, repairs, travel expenses, depreciation. The IRS requires documentation to support every claim on your return.
Spreadsheets, property management software, or even a simple folder system can help. Keep everything for at least seven years.
Talk to a Tax Expert
Working with a tax advisor or financial advisor who knows real estate is one of the best ways to stay ahead. They can help with:
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Depreciation schedules
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Complex deductions
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Choosing between ownership structures (LLC, partnership, etc.)
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Staying up-to-date with the latest tax laws and IRS publications
Trying to DIY your tax return could cost you more in the long run.
Staying Compliant With Changing Tax Rules
Tax laws change. What was deductible last year might not be this year.
Stay updated by:
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Subscribing to IRS newsletters or investor groups
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Reviewing your strategy at the end of the year
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Checking in with your advisor
Real estate investments have unique tax rules. Staying informed can help you make smart choices and reduce your tax burden.
FAQs
What are the allowable deductions that can reduce my taxable rental income?
You can deduct things like property taxes, insurance, repairs, maintenance, and management fees. Mortgage interest and some legal or professional fees count, too.
If you cover utilities or services, you can usually write off those costs as well.
Can I use depreciation to offset my rental income for tax purposes?
Yes, depreciation is fair game. You get to spread out the building’s cost—not the land—over several years.
Depreciation lowers your taxable rental income each year. For residential property, it’s typically over 27.5 years, following the IRS schedule.
Are there any specific IRS rental property rules I should be aware of to minimize taxes?
Keep clear records of all rental income and expenses. You’ll need to report everything on Schedule E when you file taxes.
If you use the property yourself, keep personal and rental use separate. Mixing them up can limit your deductions.
What tax implications should I consider when renting to a family member?
If you charge a family member below-market rent, you might lose some deductions. The IRS could treat the place as a personal residence instead of a rental.
Sticking with fair market rent and a normal lease helps you keep your deductions intact.
How is rental income reported and taxed if I have a mortgage on the property?
You have to report all rental income, mortgage or not. The good news: you can deduct the interest you pay on that mortgage.
The mortgage balance itself doesn’t change your rental income reporting, but the interest payments do lower your taxable income.
Is it possible to legally collect rent without incurring income tax, and what are the consequences?
The law says you have to report all rental income. If you skip reporting or try to dodge taxes, you could face interest charges, penalties, or even legal trouble.
If you want to lower your tax bill, stick to legal deductions and tax credits. That’s the right way to go about it.
