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Rental Property Tax Shelter

How much tax does depreciation shelter?

Enter your rental’s price, rent, and costs, plus your income and how involved you are. We’ll show whether depreciation turns the rental into a loss on paper, how much of that loss you can use against your other income this year, and what it does to your cash flow after tax.

  1. Depreciation is a deduction without a cost

    Each year you deduct 1/27.5 of the building’s value as , even though no cash leaves your account. That can turn a rental that makes money into a loss on paper.

  2. Rental losses are usually “passive”

    By default, tax law treats rental losses as : they can only offset other rental-type income, not your wages. Unused losses carry forward to later years.

  3. Some owners can use them now

    Hands-on landlords can deduct up to $25,000 a year if income is under $100,000 (phasing out by $150,000). A or a hands-on owner can deduct the full loss.
Last year’s Schedule E lists your rent and expenses. Form 1098 from your lender shows the interest you paid. The rental tax basics guide explains each rule with worked examples.
The property

What you paid and what the rental brings in and costs over a year. Leave out principal payments; only interest is deductible.

$
%
$
$
$
Your tax situation

Your income from everything else, and your tax rate. Income decides whether the $25,000 allowance applies.

$
%
How involved you are

Your role decides whether a rental loss can offset your wages this year.

Your participation level

Hands-off means a property manager runs it. Active means you make management decisions (approve tenants, set rent). A short-term rental needs an average stay of 7 days or less and (typically 100+ hours and more than anyone else, or 500+ hours), the “STR loophole.” REPS takes more than 750 hours in real estate businesses and more than 50% of your working time, plus material participation in the rentals. See the REPS guide for details.

Tax saved each year

$0/yr

Active participant: up to $0 deductible. At $180,000 of income, the $25,000 allowance has fully phased out (it ends at $150,000). The $8,909 loss is suspended: it carries forward to offset future passive income, or is released against any income when you sell the property in a fully taxable sale (§469(g)).

Building value (depreciable)

$300,000

75% of purchase price; land excluded

Yearly depreciation

$10,909

building value ÷ 27.5 years

Profit before depreciation

$2,000

rent − operating costs − interest

Taxable rental income

-$8,909

a loss on paper after depreciation

Loss you can deduct now

$0

$8,909 carries forward to later years

Tax saved per year

$0

at a 32% combined tax rate

What this means

The rental brings in $36,000 a year and costs $34,000 in operating costs and interest, leaving $2,000 before depreciation. Depreciation of $10,909 a year (the building’s $300,000 value spread over 27.5 years) turns that into a $8,909 loss on paper. At $180,000 of other income you get no allowance (it’s gone at $150,000 of income), so none of the loss can be used this year. It carries forward to offset future rental profits or the gain when you sell.

Depreciation also lowers your , and it’s taxed back at up to 25% when you sell (unless you do a 1031 exchange).

Cash flow after tax

What the rental puts in your pocket for the year once tax savings or tax owed are counted.

Cash flow before tax (rent − operating costs − mortgage interest): $2,000/yr(leaves out principal payments, so more cash leaves your account than this shows)

Cash flow after tax: $2,000/yr ($167/mo)

Plus $8,909 of losses carried forward with no time limit. They offset future passive income, or (under Section 469(g)) any income, including wages, investments, and the gain on the sale itself, when you sell the property in a fully taxable sale to an unrelated buyer.

The rules, briefly

Depreciation creates paper losses. The building’s value (purchase price minus land) divided by 27.5 years is your yearly non-cash deduction. It often turns a property with positive cash flow into a loss for tax purposes.

Section 469 makes rentals passive by default. can only offset passive income. The rest is suspended and carries forward indefinitely.

The $25,000 active-participation allowance lets active participants (a low bar) deduct up to $25,000 against wages and other income, but it phases out by 50 cents per dollar from $100,000 of AGI to zero at $150,000.

REPS or a hands-on short-term rental gets around entirely. Losses become non-passive and fully deductible against any income. That’s why some W-2 earners buy short-term rentals or have a spouse without a W-2 job manage the rentals.

At sale, all depreciation “allowed or allowable” is taxed back at up to 25% federal (unrecaptured gain), plus any remaining gain at long-term rates. Recapture applies whether or not you took the deduction, so skipping depreciation doesn’t help later; you only lose the deduction now. Personal property from a cost segregation study (5-year and 7-year items) is recaptured at full regular rates under (no 25% cap). A defers all of it. See the 1031 calculator.

Cost segregation can speed up depreciation (front-loading $30,000 to $50,000 or more in year 1 on larger properties) but creates recapture at regular income rates on sale. It’s usually worth it on buildings of $500,000 or more. See the full guide for details. Tax law depends on your specific facts, so consult a CPA.

Results are estimates based on your inputs and the assumptions on this page, not quotes or advice. A lender, servicer, or tax advisor will give you different numbers. Disclaimer

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Terms used on this page

Whether a rental loss lowers your tax this year depends on the rules defined below.

Depreciation
A yearly deduction for wear and tear on a rental building: its value (not the land) divided by 27.5 years. No cash is spent, but it lowers your taxable rental income.
Paper loss
When depreciation makes a rental show a loss for tax purposes even though it brings in more cash than it costs.
Passive loss
Rental losses are “passive” by default and can only offset other passive income, not wages. Unused losses carry forward to later years.
Active participation ($25,000 allowance)
If you make the management decisions and own at least 10%, you can deduct up to $25,000 of rental losses a year. It phases out between $100,000 and $150,000 of income.
Material participation
Being involved in an activity enough to pass IRS hour tests, most commonly 500+ hours a year, or 100+ hours and more than anyone else.
REPS (real estate professional status)
Spending more than 750 hours a year, and more than half your working time, in real estate businesses. With material participation, rental losses can offset any income.
Short-term rental (STR) rules
If the average guest stay is 7 days or less and you materially participate, the property isn’t treated as a passive rental, so losses can offset wages.
AGI (adjusted gross income)
Your total income minus certain adjustments, the last line on page one of Form 1040. It decides how much of the $25,000 allowance you get.
Depreciation recapture
When you sell, the depreciation you claimed (or could have claimed) is taxed back at up to 25% federal. A 1031 exchange can defer it.

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