Topic 08 · 6 min read
Where Taxes Come Into the Picture
A preview of everything the later installments unpack.
Rental income is taxable, but only after subtracting the costs of earning it — and one of the largest of those costs, depreciation, is not money you spend at all. That is why a property can put cash in your pocket and still show little or no taxable profit. When you sell, a different set of rules decides what is taxed and at what rate.
What to know
- Income minus expenses
- Rent is reported, then reduced by interest, taxes, insurance, repairs, management, and depreciation.
- Depreciation, the paper expense
- The law lets you write off the building's cost a slice at a time over many years, even while it rises in value.
- Repairs versus improvements
- Fixing something is usually deducted now; upgrading it is added to the property's cost and written off slowly.
- Selling has its own rules
- Profit on a long-held property is usually taxed at lower long-term rates, but the depreciation you claimed gets settled up too.
The tax benefit
Between deductible operating costs and depreciation, a well-run rental often reports far less taxable income than the cash it produced.
Worked example
Cash versus taxable profit
A rental produces $3,000 of cash for the year. A $7,000 depreciation deduction turns that into a $4,000 loss on paper, even though the bank account grew.
Watch out for
- Losses from rentals are often limited until you sell, depending on your income and involvement.
- Depreciation is settled up at sale whether or not you claimed it.
- Rules differ sharply for short-term rentals and for property held in a business.
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