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🏠 Understanding Rental Properties In 2026

Primary Residence VS. Rental Property

With your primary residence…

  • Your property tax deduction may be limited due to the SALT CAP.
  • Insurance, regular maintenance, tax prep fees, etc. are not deductible.
  • Money spent on large improvements is not deductible until you sell your home.

(For more on the tax side of your own home, see our Primary Residence article.)

With rental properties…

  • Tax expenses for rental properties are not subject to the same cap as a primary residence.
  • You can claim additional expenses – insurance, utilities, HOAs, mileage to and from the rental, your tax prep fee, etc.

And a big one is…

👊 Depreciation

When you buy a rental property, the government allows you to separate the land and the buildings and ‘depreciate’ the building. This means that you take the value of the building (let’s say $275,000) and depreciate it over 27.5 years. In this case, you would get an extra $10,000 annual deduction each year against your rental income. So every year, you can pocket an extra $10,000 without paying taxes on it.

❗️Depreciation Recapture❗️- An important thing to note here is that when you sell your property for more than you paid for it, you have to recapture any depreciation previously used, and pay taxes on it. So in the example above, if you held your property for 5 years, you would recapture $50,000 in the year sold. Generally, this tax is usually at a lower income rate for good earners, but it is something to consult a tax professional on before selling.

💰 Income Considerations

Due to the structure of rentals (especially depreciation), many rental properties lose money on paper each year. What happens to those losses depends on your income:

  • Under $100,000 – If you “actively participate” in managing the rental, you can generally deduct up to $25,000 of those passive losses against your ordinary income each year.
  • Between $100,000 and $150,000 – That $25,000 allowance gradually phases out.
  • Over $150,000 – You generally cannot deduct passive rental losses against ordinary income in the current year (unless you meet an exception, like the strategies below).

Here’s the part people miss: the losses you can’t use don’t disappear. They carry forward indefinitely — you can use them in a future year when your income drops, or all at once when you eventually sell the property. So even if you can’t deduct them today, you’re not losing them.

🏆 The “Real Estate Professional” Path

For high earners, the classic way to deduct rental losses against your ordinary income (like W-2 or business income) is to qualify as a Real Estate Professional. To qualify, you or your spouse generally need to spend more than 750 hours a year on real estate activities, and more than half of your total working time in real estate.

It’s a high bar, and the IRS scrutinizes it — so good documentation matters. But for full-time investors, it can be the difference between losses that just sit on the shelf and losses that offset your other income today.

🤩 Short-Term Rental Hack

If your rental property makes money, you don’t need to consider this. However, if it loses money and you’re a good earner, there’s a workaround for short-term rentals — and you don’t need to be a real estate professional to use it.

If the average rental period for your property through the year is 7 days or less, the IRS treats it as an “active” income stream instead of a “passive” one. Combined with materially participating in the rental (being genuinely involved in running it), you can treat it more like a small business — and those losses can offset your ordinary income.

This is especially relevant if you own a short-term or vacation rental. Done right, a property that “loses money” on paper can shelter a meaningful chunk of your other income.

Pro Tip – More advanced investors pair this with bonus depreciation and a cost segregation study. A cost seg study breaks your building into shorter-life components (appliances, flooring, landscaping, and more), and thanks to the 2025 tax law, 100% bonus depreciation is back and now permanent for property placed in service after January 19, 2025. That lets you front-load a large deduction in the year you buy — sometimes a very large one. If you’re considering this, I highly recommend a consultation with your tax professional before purchasing, as the details matter.

🧾 The QBI Deduction

If your rental activity rises to the level of a trade or business — the IRS offers a safe harbor at 250+ hours of rental services per year — it may qualify for the Qualified Business Income (QBI) deduction, worth up to 20% of your net rental income. Not every rental qualifies, but if yours does, it’s a straightforward way to knock down the tax on your rental profit.

👍 Long-Term Capital Gains

When you sell a rental you’ve held longer than a year, your profit is generally taxed at long-term capital gains rates — often 15%, or 20% at higher incomes — rather than ordinary income rates. If you’re in a higher tax bracket (32% or above), that’s a significant savings. Capital gains are also not subject to additional taxes such as FICA, while earned income wages (W-2 & 1099) are. (For the full breakdown, see our Capital Gains article.)

🏡 The Primary Residence Exclusion

Here’s a powerful one if your rental was ever your home — or becomes your home before you sell. If you live in the property as your primary residence for at least 2 of the last 5 years, you may be able to exclude a large chunk of the gain from taxes entirely — up to $250,000 if you’re single, or $500,000 if you’re married filing jointly.

A common strategy is to convert a rental into your primary residence (or the other way around) and time the sale to land inside that 2-of-5-year window. Two things to keep in mind: any depreciation you took while it was a rental still has to be recaptured and taxed, and the exclusion is generally prorated for the years the home was used as a rental rather than lived in. Handled right, though, it can shelter a significant gain.

📈 1031 Tax Exchange

This is an advanced way to defer taxes until later. You cannot do this with your primary residence, only with an investment property.

If you want to upgrade to a bigger property without paying the taxes, you can use the above. Here is how it works…

  • Contact a licensed 1031 Tax Exchange escrow company – You must use one. This is not an election you can make on your tax return.
  • Once you sell your rental, the escrow company will hold this money. Then…
    • You have 45 days to identify replacement properties
    • You have 180 days to close on the purchase of a new building.

  • To avoid taxes, you must reinvest the entire sale proceeds into the replacement property. Any funds not reinvested (known as ‘boot’) may be subject to capital gains tax.

When executed properly, there is no taxes paid on the sale of the first building. Taxes owed will roll over into the next property, allowing you to upgrade without taxation.

As always, thanks so much for reading! If you enjoy reading, please share these articles with anyone (subscribe here) that you feel might benefit.

If you have any additional questions, please reach out. We help individuals and businesses year-round with personal and business tax services.

Thanks,

– Taxman

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