Gizane Campos Owning rental property can be a great way to build wealth, but paying taxes on that income can quickly eat into your profits. But with the right strategies, you can significantly reduce the amount of tax you pay on rental income.
In this article, we’ll explore proven techniques that real estate investors use to legally minimize taxes and, in turn, maximize their earnings. Whether you’re a seasoned landlord or just getting started, these tips can help you keep more of what you earn.
What is Rental Income and Why is it Taxed Differently?
If someone pays you money on a regular basis to stay in a property you own as a form of rent, that qualifies as rental income.
It’s not only referring to residential homes but also Airbnbs, holiday homes, bed-and-breakfasts, guesthouses and sub-letting a room in your house.
Rental income is taxed differently because it’s passive income, not earned. It doesn’t matter whether it is your primary source of income or a supplement.
How to Pay Less Taxes on Rental Income Legally
Leverage Deductions
You need to be aware of which tax deductions are allowed when it comes to rental income. In other words, what expenses can you remove from you overall income so that you’re not taxed on it.
The following deductions you can utilize to your advantage:
- Mortgage interest
- Property taxes
- Depreciation
- Repairs and maintenance
- Property management fees
- Insurance
- Utilities (if paid by you)
Let’s expand on three of the most important deductions:
Mortgage Interest
If you have a mortgage on your rental property, it can be one of the biggest tax-saving tools at your disposal.
The interest portion of your monthly mortgage payments (not the principal) is fully deductible as a rental expense.
This deduction can significantly reduce your taxable rental income, especially in the early years of a loan when interest makes up the bulk of your payment.
You can also deduct interest on any loans used to improve the rental property or to refinance an existing mortgage. Remember, only the interest is deductible.
Maintenance and Repairs
All day-to-day, necessary repairs and maintenance expenses related to your rental property are deductible in the year they are incurred.
This includes things like:
- Fixing a broken furnace
- Painting the interior or exterior
- Plumbing or electrical repairs
- Lawn care and pest control
- Replacing a broken window or door
Major upgrades (like a new roof or a kitchen remodel) are considered improvements and are not seen as due to depreciation. Thus, they are not deductible in full.
Repairs, on the other hand, keep your property in good working condition and can be deducted immediately. This helps reduce your taxable income for the year.
Depreciation
Depreciation is a powerful tax advantage when it comes to owning rental property.
Over a period of 27.5 years, you can deduct the cost of the building. This is based on the idea that the structure wears out over time, even if it’s actually appreciating in value.
If, for example, you purchase a rental property for $300,000, and $250,000 of that is allocated to the building, you can deduct around $9,090 per year ($250,000 ÷ 27.5).
This is a non-cash deduction, meaning you can reduce your taxable income without needing to spend money.
This creates a paper loss, meaning you see a decline in the records but not in physical cash. This type of “loss” helps:
- Lower your tax bill even if you’re earning positive cash flow
- Potentially offset other passive income
- Defer taxes until you sell
Note that when you sell that rental property, you will likely owe depreciation recapture tax but the long-term tax deferral is usually well worth it.
Utilize Tax-Advantaged Accounts
Tax-advantaged accounts refer to accounts that are exempt from tax, tax-deferred or have other tax benefits. These are useful in helping to grow wealth.
You generally can’t hold physical rental properties in retirement accounts, but you can use certain tax-advantaged vehicles to invest in real estate indirectly or through setups like:
- Self-Directed IRAs (SDIRAs) and Solo 401(k)s: Allow you to invest in real estate directly such as buying a rental property through your retirement account. All rental income generated this way grows tax-deferred (in traditional accounts) or tax-free (in Roth accounts).
- Health Savings Accounts (HSAs) and Coverdell ESAs: Can’t hold real estate directly, but they can invest in real estate-related assets like REITs or real estate ETFs, offering tax-free growth if used for qualified expenses.
1031 Exchange for Deferring Taxes
If you’re planning to sell a rental property, the 1031 exchange can help you defer capital gains taxes and keep your real estate portfolio growing tax-free.
A 1031 exchange lets you sell one investment property and roll the proceeds into another similar property without immediately paying taxes on the gains. This means you can:
- Avoid capital gains tax
- Defer depreciation recapture tax
- Use more capital to reinvest and scale your portfolio
Note that you must follow strict rules to qualify, including:
- Identify a replacement property within 45 days
- Close on the property within 180 days
- Both properties must be held for investment or business use
Real Estate Investment Trusts (REITs) for Tax-Free Earning
Real Estate Investment Trusts (REITs) are good for hands-free real estate management. You get access to properties that generate rental income without the landlord responsibilities.
Types of REITs for tax-efficient or tax-free rental income:
- REITs in Roth IRAs or Roth 401(k)s: All income, including dividends from REITs, grows and can be withdrawn completely tax-free after retirement age.
- REITs in Traditional IRAs: Taxes are deferred until withdrawal.
REITs may qualify for a 20% Qualified Business Income (QBI) deduction, which can lower the tax rate on dividends for many investors.
REITs must distribute at least 90% of their taxable income to shareholders, making them excellent sources of passive income.
While the dividends are typically taxed as ordinary income outside of retirement accounts, holding them in tax-advantaged accounts helps maximize your after-tax return.
How to Reduce Tax on Rental Income Through Smart Structuring
Set up an LLC for tax benefits
You can get legal protection and potential tax advantages if you form a Limited Liability Company (LLC) to hold your rental property.
While an LLC itself doesn’t reduce taxes by default, it can give you flexibility in how your rental income is taxed.
An LLC with only one member is treated as a disregarded entity. This means rental income is reported on your personal tax return and not as a separate business.
However, once your rental operation grows or becomes more active, you can do the following:
- Add members and be taxed as a partnership, which opens additional planning opportunities.
- Separate personal and business finances for cleaner deductions and expense tracking.
The real value of an LLC lies in liability protection and the ability to pair it with other strategies, like pass-through deductions and 1031 exchanges.
Use pass-through deductions
Thanks to the Tax Cuts and Jobs Act (TCJA), many landlords qualify for the Qualified Business Income (QBI) deduction, also known as the 20% pass-through deduction.
This deduction lets eligible taxpayers deduct up to 20% of their net rental income from their taxable income.
Here’s how it works:
- Your rental activity must qualify as a trade or business under IRS rules.
- If eligible, and your total income falls below certain thresholds, you may qualify without restrictions.
Even if your rentals are considered “passive,” you might still qualify if you regularly engage in the management, maintenance, or operation of the property.
Classify your property as a business
When you structure your rental operation more like a business than a passive investment, you open the door to additional tax deductions and strategic advantages.
Arranging your rental activity as a business can allow you to:
- Write off a home office used to manage the property as part of your deductibles.
- Deduct business travel, phone, internet, software, and professional education.
- Contribute to a retirement account (if you’re actively involved in the business, especially in short-term rentals or property flipping)
- Become eligible for the QBI deduction
To make this classification more likely, treat your rental like a business:
- Set up a separate business bank account
- Keep clean books and records
- Advertise, manage tenants, and maintain properties in a professional manner
How to Save Tax on Rental Income by Claiming Tax Credits
Tax credits refer to an amount of money that a taxpayer can subtract from the taxes they owe. It differs from tax deductions as those simply lower the amount of taxable income.
Solar and Energy Efficiency Tax Credits for Rental Properties
If you’re a landlord looking to reduce your rental income tax liability, investing in energy-efficient upgrades can unlock valuable tax credits.
Renewable energy tax credits refer to financial incentives offered by the government for investing in clean, sustainable energy sources such as solar panels.
In the United States, you can get tax credits or incentives under the following:
- Residential Clean Energy Credit: property owners can claim a percentage of the cost of installing qualifying solar systems on their rental properties.
- Inflation Reduction Act and Section 179D of the tax code: energy efficiency tax credits can apply to landlords who make eligible improvements like upgraded insulation, energy-efficient windows, HVAC systems, or Energy Star appliances.
- Qualified Business Income (QBI) deduction: eligible rental property owners can deduct up to 20% off their net rental income. To qualify, your rental activity must be considered a trade or business under IRS guidelines, often requiring regular and continuous involvement.
Opportunity Zone Investments for Rental Properties
If you invest in rental property located in a government-designated Opportunity Zone, you may be eligible for significant tax benefits. These zones were created to encourage economic development in underinvested areas by offering incentives to investors.
By reinvesting capital gains into an Opportunity Zone Fund, landlords can defer and even reduce the tax owed on those gains. If the investment is held for at least 10 years, any additional gains from the Opportunity Zone investment itself can be entirely tax-free.
First-Time Landlord Tax Benefits
First-time landlords can benefit from a variety of deductions and tax credits. When you’re just starting out, certain startup and operational costs related to setting up your rental business, such as repairs or advertising, can be deductible.
There may also be state or local incentives designed to encourage investment in housing developments in certain areas or to support new landlords just entering the market, such as tax abatements.
International Strategies to Pay No Taxes on Rental Income
Owning rental properties in tax-free countries
Some countries around the world offer little to no taxation on rental income, making them attractive destinations for international real estate investors who want to legally minimize their tax liability.
Countries with low to no taxes on foreign-sourced rental income include:
- Monaco
- United Arab Emirates
- The Bahamas
- Cayman Islands
- St. Kitts & Nevis
In many of these jurisdictions, there is no personal income tax at all, or foreign income (like rental income earned abroad) is not taxed.
Some even offer attractive property markets with growing tourism or expat communities, making short-term rentals viable.
Set up offshore real estate companies
Another advanced strategy is to hold international rental properties through an offshore corporation or trust.
Using this tactic might help:
- Limit your exposure to foreign property taxes
- Add layers of asset protection
- Allow you to defer or reduce some tax obligations
- Make estate planning and succession easier
Some popular jurisdictions for forming offshore real estate holding companies include:
- British Virgin Islands
- Panama
- Singapore
- St Kitts & Nevis
- Malta
Using an International Business Company (IBC) or foreign LLC can help investors separate property ownership from personal identity, gaining privacy and potential tax shelter.
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Double taxation agreements
Many countries have double taxation treaties that can prevent you from being taxed twice on the same rental income (once in your home country and the second time where the property is located).
These treaties typically allow you to:
- Offset taxes paid overseas with a Foreign Tax Credit (FTC)
- Exempt a portion of the rental income depending on the treaty
- Reduce or eliminate withholding taxes on rental income remitted back home
Frequently Asked Questions About Reducing Rental Income Tax
Can I use depreciation to lower rental income taxes?
Yes, depreciation is an annual allowance for the wear and tear, deterioration, or obsolescence of the property that you can claim back.
Are there countries with no property taxes?
Yes, there are countries where you don’t pay tax on property. These include:
- Croatia
- Liechtenstein
- Monaco
- Malta
- Georgia
- Fiji
- Cook Islands
- Cayman Islands
- Dominica
- Turks and Caicos
- United Arab Emirates (UAE)
- Gulf Countries like like Bahrain, Kuwait, Oman, Qatar and Saudi Arabia
Can I offset rental income with losses?
Yes, rental income can be reduced by any permissible expenses incurred during the period that the property was let.
Note that only expenses incurred in the production of that rental income can be claimed.
What are the tax benefits of renting out a furnished property?
You can claim depreciation on the furniture over time due to wear and tear. This deduction allows you to spread the cost of replacing the furniture over several years.
Are there penalties for not declaring rental income?
Yes, as with any tax obligations, not declaring rental income can bring with it fines and interest.
How does owning rental property through an LLC affect taxes?
Registering a rental property as an LLC allows for pass-through taxation. This means the income generated from rental properties is reported on your personal tax return, potentially lowering your overall tax burden.
What is the impact of double taxation treaties on rental income?
Double Taxation Agreements (DTAs) can be beneficial to taxpayers as they prevent an individual earning an income in one country while being a resident of another country from paying taxes twice.
