How some landlords pay no taxes on rental income

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As tax season approaches, you might be asking yourself, “Is rental income taxable?” Or, “Do you pay tax when you sell a rental property?” The short answer is that it depends. Rental income is often taxable, but in some cases, the IRS may not require you to pay taxes on rental income or the sale of a property. But even if your rental income is taxable, there are ways to lower or defer your tax bill.

TurboTenant shares how you can reduce your tax liability and how to pay no taxes on rental income — legally.

How to Pay No Taxes on Rental Income

So, how do you pay no tax on rental income? Use the Augusta rule, which allows you to rent out your home for up to 14 days without having to report or pay tax on the income.

Follow these criteria to make sure your rental income is tax-free:

• The property you rent out must count as your personal residence or vacation home.
• The rental rate must be reasonable and in line with current market rates for the area.
• The total number of rental days is 14 or fewer.

If you fail to meet any of these conditions, the Augusta rule won’t apply to you. You’ll need to report the rental income and pay taxes on it. Don’t worry, though; there are other ways to reduce your tax liability.

Maximize Deductions, Minimize Taxes

Ready to reduce your tax liability for your rental property? Start by maximizing your deductions. It’s easy to skip a transaction or fall victim to a bad formula when you track your expenses on a spreadsheet. Misclassifying a purchase is a simple mistake if you use generic accounting software. Those errors are small, but they’re costly come tax time because they affect your deductions.

Deductions reduce the amount of income that the IRS will tax. That’s why making the most of your deductible expenses is important.

How, you ask? Keep your books updated. Reconcile your accounts to ensure that every transaction is recorded. As a rental property owner, you can deduct these expenses:

• Advertising
• Certain travel expenses
• Eviction-related costs
• Fees for accounting or property management software
• Home office costs
• Insurance premiums
• Legal and professional fees
• Mileage
• Mortgage interest
• Property maintenance and repair costs
• Property taxes
• Service fees from hosting sites, like Airbnb or Vrbo

Every deduction helps reduce your tax bill, so taking the time to review and update your books is worth it.

Depreciation: A Key Deduction for Landlords

Depreciation can be a significant deduction and a key part of reducing your tax liability, but many rental property owners miss out on it. So let’s clarify what depreciation is and how it works for you.

With depreciation, you can reclaim the cost of a fixed asset over the asset’s expected lifespan. These deductions account for the wear and tear on an asset and reflect the change in its value over time.

Most importantly, depreciation is a noncash deduction, so it can significantly reduce your tax liability without incurring any additional costs. Want to lower your taxable income by tens of thousands of dollars each year? Track your depreciation and take the deduction.

The IRS allows for different types of depreciation, too. With accelerated or bonus depreciation, you can take higher deductions sooner, instead of spreading out the depreciation expense evenly over time.

Cost segregation studies are another option that allows you to reclassify your fixed assets and speed up depreciation.

Reduce and Defer Capital Gains

When you sell a rental property at a profit, those profits are called capital gains — and they’re taxable. Let’s say you bought a residential rental property for $120,000, then held it for several years before selling it for $155,000. You’d owe capital gains taxes on the $35,000 profit from your investment. How much you’d owe depends on how long you owned the property before selling it.

However, you can defer those capital gains taxes, lowering your immediate tax liability. Here’s how.

Qualified Opportunity Funds

With a qualified opportunity fund, you can invest the funds from the sale of your property without having to pay capital gains taxes when you sell. The IRS has guidelines for qualified opportunity funds. For instance, you must invest the proceeds within 180 days of the sale.

Note that this doesn’t eliminate your tax liability; opportunity funds can reduce or defer your tax bill, but you’ll still need to pay this tax later on. The longer you participate in the fund, the more tax breaks you’ll receive.

Like-Kind Exchanges

Another option to defer capital gains taxes is the 1031 exchange. Also known as a like-kind exchange, this tax strategy enables you to exchange one investment property for another. Most importantly, you won’t have to pay capital gains taxes right away for the property involved in the exchange.

These exchanges come with conditions and a strict timeline, but depending on how you use them, a successful exchange can provide you with several benefits:

• A reset of your property’s depreciation.
• Consolidation of multiple properties into a single property.
• Deferred capital gains tax.
• Diversification of your portfolio.
• Investment in a new property with a higher ROI.
• Potential to pay capital gains tax at a lower rate later on.

Property Conversions

How do you sell rental property without paying taxes? There’s a way to reduce, or even eliminate, your capital gains taxes: Convert a rental property into your personal residence before selling it.

The IRS allows homeowners to exclude a certain amount of capital gains when they sell their primary residence. How much you can exclude depends on your tax filing status. If you file as single, you can exclude up to $250,000 of profit. For folks who are married and filing jointly, you can exclude up to $500,000.

For this strategy to work, you must pass the ownership and use test:

• Use the home as your primary residence for at least two of five years.
• Don’t claim the capital gains exclusion on the sale of another home within the last two years.

Long-Term Investment Properties

So, how much is the tax on rental income? Your capital gains tax depends in part on how long you’ve owned the property you want to sell. That’s because there are two kinds of capital gains: short-term and long-term.

The IRS taxes short-term capital gains at the same rate as your income, and properties held for a year or less count as a short-term investment. Reduced rates apply for long-term gains, though.

That means if you hold your property for at least one year, you’ll automatically reduce your tax liability.

Increased Property Basis

Capital gains also depend on your property’s basis—the cost of purchasing the property plus the cost of capital improvements. For example, let’s say you bought a rental property for $150,000 and then installed a new roof. The roof cost $8,000. Your new property basis would be $158,000.

When you sell a property, the profits are your capital gains, and the lower your profit, the lower your taxable gains will be. Before you sell, ensure that you’ve adjusted the property’s basis to account for any capital improvements.

Talk with your CPA or tax advisor to estimate what your capital gains may be. It’s possible that a strategic capital improvement to the property before a sale would have a significant effect on your potential tax liability.

Remember, a higher basis equals a lower capital gain, reducing your tax burden.

Offset Passive Income with Losses

Rental losses are a common occurrence for real estate investors. And unless you qualify as a real estate professional, the IRS treats rental losses and income as a passive activity. That’s different from your regular wages and salary, known as active income. Generally, the IRS doesn’t allow investors to deduct passive rental losses from regular income.

The good news is that you can use rental losses to offset your other passive income and reduce your taxable income.

Even better? You can carry rental losses over from year to year. Here’s how that helps in real life.

Let’s say you had a rental loss of $20,000 last year, but this year, you made a profit of $30,000. You can apply that loss to your profit from this year, reducing your taxable income to $10,000. This gives you a major tax break.

You don’t need to use the full loss in a single year, either. In this example, if you’d had a $10,000 profit this year, you could apply part of the loss. That would give you no taxable income for this year, plus you could carry the remaining $10,000 loss over to use in later years.

Note: Federal and state tax laws differ. California doesn’t recognize the IRS real estate professional designation, which will affect your state tax liability. Some states, including Texas, don’t even have an income tax.

The Special Allowance for Rental Property

Even though the IRS has limits on how you can apply passive losses, rental property owners qualify for a special allowance. They can use up to $25,000 of rental losses to offset active income.

The allowance works like this: Say your rental property has a $20,000 loss this year, and you also have another job, one with W-2 wages. That W-2 income is taxable, but you can lower your taxable income by applying the $20,000 loss. You’ll pay less tax because of your lowered income. And depending on your income, this reduction could move you to a lower tax bracket, meaning you’ll qualify for a lower tax rate.

Disclaimer: Your tax bracket determines your federal income tax rate, but state and local taxes may also apply. These rates vary widely. Work with a tax professional to assess your specific situation.

The Short-Term Rental Tax Loophole

If you own short-term rentals (STRs), you have another option to reduce your taxable income: the Airbnb tax loophole. This strategy hinges on reclassifying the income from your STRs, shifting it from passive to active.

To use this strategy, you’ll need to meet IRS requirements for how you participate in the business and how the rental property is used.

Why Smart Tax Planning Matters for Landlords

With smart planning, landlords can legally reduce, or even eliminate, taxes on rental income. From deductions and depreciation to 1031 exchanges and short-term rental strategies, every move matters. Stay organized, work with a tax pro, and watch your profits grow.

This story was produced by TurboTenant and reviewed and distributed by Stacker.