The most significant advantage of investing in real estate is the ability to pay almost ZERO TAXES on the rental income you earn.  I briefly mentioned this in an earlier post about 10 advantages of investing in real estate instead of stocks.  I want to elaborate a little bit more on the tax advantages to illustrate how valuable real estate is as an investment. 

I previously explained how to generate cash flow from real estate.  Once you own a rental property (like a house or an apartment), and once you have passive rental income coming in on a monthly basis, you don’t have to worry about the taxes you’d have to pay on that income because you can probably eliminate most of it.

[Disclaimer: The following is not intended as legal advice or accounting advice.  Consult your own attorney or accountant to confirm that you can claim the same deductions on your rental property.]

A Landlord’s Deductions

There are four main tax deductions you can claim as the owner of a rental property.  They are classified as rental expenses, and they reduce the amount of your taxable rental income.  The four deductions are (1) mortgage interest, (2) property taxes, (3) depreciation, and (4) repairs and maintenance. 

1) Mortgage Interest

Obviously, this is the interest on the mortgage you received from the lender to buy the property.  It can be a hefty amount on a 90/10 or 80/20 mortgage.  The beauty of this, however, is that the tenant is the one paying the interest (via his or her rent payment).  But YOU, not the tenant, get to claim the deduction on the interest.   

2) Property Taxes

Same goes for property taxes.  The taxes assessed by the state on the property you own are paid by the tenant (via his or her rent payment).  And YOU get to claim the deduction.

3) Depreciation

This is where it gets juicy.  You can deduct a portion of the cost of the property over several years.  This depreciation breaks down into two parts:

(a) Depreciation of the property itself (not the land) - This includes the structure (the walls, roof, etc.).

(b) Depreciation of appliances, furnishings, and improvements - This includes refrigerators, ovens, dishwashers, furniture, etc.

This is almost like a guaranteed deduction every year because all of these items depreciate constantly over time.

4) Repairs & Maintenance

You can also deduct the full cost of repairs and maintenance performed on the property as long as they are ordinary, necessary, and reasonable.  These repairs include all the things that you normally hate to do as a homeowner: fixing leaks and broken windows, re-painting, fixing floors, plastering, lawn care, pest control, etc.

Once you deduct these expenses, you might be able to wipe out most, if not all, of your taxable rental income and leave just a small amount of income on which you’d have to pay taxes. 

It’s important to realize that nowhere else can you earn an income and get to pay almost zero taxes on that income.   

You Can Even Report a Loss

At the end of the year, if the rental expenses (the cost of the items above) for a given property exceed the rental income, most landlords can report a loss on their tax returns of up to $25,000. 

How Can Uncle Sam Allow You to Get Away With This?

The answer is simple.  The tax laws are designed to encourage this type of investment because it provides affordable housing to people who can’t afford to buy.  In general, the tax laws encourage investment and entrepreneurship and penalize employees and their earned income.

You’re really not getting away with anything.  You’re also not stealing money from anyone.  These deductions represent a perfectly legal way to reduce your tax burden as a real estate investor.   

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