Real estate gets more favorable tax treatment than most investments, but the benefits come with rules attached. Depreciation can shelter rental income, a 1031 exchange can defer gain, and selling your home can be largely tax-free. Each one has limits that are easy to trip over.
This guide walks through the main breaks for homeowners and small landlords, with the rules as the IRS describes them for 2025 returns. Most of these rules didn't change for 2026, but check the current publications before you file.
Depreciation: deducting a building over time
When you buy a rental property, you can't deduct the purchase price all at once. You recover the cost of the building through depreciation over its recovery period:
| Property type | Recovery period (GDS) |
|---|---|
| Residential rental property (houses, apartments) | 27.5 years |
| Nonresidential real property (offices, retail, warehouses) | 39 years |
Land is never depreciable. As IRS Publication 527 puts it, land "doesn't wear out, become obsolete, or get used up." So you split your purchase price between land and building and depreciate only the building.
Here's a rough example. Say you buy a rental for $330,000, and $55,000 of that is land. The $275,000 building portion, depreciated over 27.5 years, gives you about $10,000 a year in deductions, before the partial-year convention in the first and last years. That deduction reduces your rental income even though no cash left your pocket.
Depreciation starts when the property is placed in service, meaning when it's "ready and available" for rent, even if no tenant has moved in. The 100% bonus depreciation restored by the One Big Beautiful Bill Act (OBBBA) doesn't apply to rental buildings themselves, because 27.5-year and 39-year property aren't eligible.
Passive activity rules and the $25,000 allowance
Rental activities are generally passive, and passive losses can usually offset only passive income. There's an important exception for regular landlords.
If you actively participate in your rental, you may deduct up to $25,000 of rental losses against wages and other nonpassive income. Active participation is a fairly low bar. It means making management decisions "in a significant and bona fide sense," such as approving tenants, setting rent terms and approving expenses, and owning at least 10% of the property.
The allowance phases out as income rises. It's reduced by 50% of your modified adjusted gross income (MAGI) over $100,000, so it's gone completely at $150,000. Married people filing separately who lived apart all year get half the amount, $12,500.
Losses you can't use aren't lost. They carry forward to future years and can offset future rental income. When you sell your entire interest in the activity to an unrelated buyer in a fully taxable sale, the remaining suspended losses are generally allowed in full. The calculation is done on Form 8582.
Real estate professional status
If real estate is your main line of work, you may qualify as a real estate professional. Then your rental losses aren't automatically passive. You must meet both tests for the year:
- More than half of the personal services you performed in all trades or businesses were in real property businesses in which you materially participated, and
- You performed more than 750 hours of services in those real property businesses.
You also have to materially participate in the rental activity itself. This status is valuable and is often questioned, so keep a contemporaneous log of your hours.
1031 like-kind exchanges
A 1031 exchange lets you sell investment or business real estate and roll the gain into replacement property without paying tax now. Since 2018, it applies only to real property held for business or investment, not property held primarily for sale, and not your personal home.
The deadlines are strict:
- 45 days: Identify the replacement property in writing within 45 days after you transfer the property you're giving up.
- 180 days: Receive the replacement property within 180 days or by the due date of your tax return (including extensions), whichever comes first.
Any cash or non-like-kind property you receive (often called "boot") is taxable in the year of the exchange. U.S. and foreign real estate aren't like-kind to each other. Exchanges with related parties carry a two-year holding requirement. You report the exchange on Form 8824.
Depreciation recapture when you sell
When you sell a rental at a gain, the part of the gain that comes from depreciation is treated differently. For real property held more than a year, this "unrecaptured section 1250 gain" is taxed at a maximum 25% rate, rather than the usual long-term capital gains rates. You owe this on depreciation allowed or allowable. If you skipped depreciation you were entitled to, the IRS still treats it as taken. That's one more reason to claim it every year. See our article on understanding capital gains for how the rest of the gain is taxed.
Mortgage interest
On a rental, mortgage interest is a rental expense on Schedule E. On your own home, it's an itemized deduction on Schedule A. You can deduct interest on up to $750,000 of acquisition debt ($375,000 if married filing separately), or $1 million ($500,000) for debt taken on before December 16, 2017. Home equity loan interest is deductible only if the money was used to buy, build or substantially improve the home.
The home sale exclusion
When you sell your main home, you may exclude up to $250,000 of gain, or $500,000 on a joint return. Generally you must have owned the home and lived in it as your main home for at least two of the five years before the sale, and you can't have used the exclusion on another home in the prior two years.
If you ever rented out the home or used part of it for business, gain equal to depreciation after May 6, 1997 can't be excluded. If you get a Form 1099-S, you must report the sale even if all the gain is excludable. If you work from home, our article on the home office deduction explains how that interacts.
When it's worth getting help
A single rental with steady income is manageable on your own. Professional help pays off when you're planning a 1031 exchange (the deadlines leave no room for error), claiming real estate professional status, selling a property you've depreciated, or converting a rental to a residence or vice versa. Higher-income investors may also want our tax strategies for high-net-worth individuals.
Our CPAs and Enrolled Agents handle rental schedules, depreciation and sale reporting as part of personal tax preparation. Book an appointment to talk through your properties.
Sources
- IRS Publication 527 (2025), Residential Rental Property
- IRS Publication 946 (2025), How To Depreciate Property
- IRS Publication 925 (2025), Passive Activity and At-Risk Rules
- IRS: Instructions for Form 8824 (2025), Like-Kind Exchanges
- IRS Topic No. 409, Capital Gains and Losses
- IRS Publication 936 (2025), Home Mortgage Interest Deduction
- IRS: 2025 Instructions for Schedule D (Form 1040)
- IRS Topic No. 701, Sale of Your Home
- IRS Publication 523, Selling Your Home
General information, not tax advice. Tax rules change and depend on your situation. Figures are for tax year 2026 unless noted; confirm current amounts at IRS.gov or talk to a Stellar Tax professional before acting.