7 Real Estate Tax Benefits to Supercharge Your Rental Returns in 2027

BiggerPockets Real Estate Podcast

Dave Meyer breaks down seven strategic tax advantages available to real estate investors, using a sample $300,000 duplex deal to illustrate how specific IRS provisions can dramatically reduce taxable

Key takeaways

• Standard residential depreciation uses a 27.5-year schedule applied only to the building value, not land, often reducing taxable rental income to zero.
• Cost segregation combined with bonus depreciation (restored to 100% for properties acquired after January 19, 2025) allows investors to accelerate deductions by categorizing property components into shorter useful-life buckets like 5, 7, or 15 years.

Main topics

• Depreciation strategies
• Cost segregation & bonus depreciation

Notable quotes

The IRS just treats real estate differently from almost everything else.

Conclusion

Investors can significantly accelerate portfolio growth and preserve c

Transcript preview

Speaker 1 (0:00) Do you want to pay less tax and keep more of your hard-earned money? If you were to get a raise at work, let's call it $2,500 a year, after a 22 % federal income tax, 7.6 % payroll tax, and 5 % for state tax, your take-home pay would be just $1,640 instead of $2,500. But if you earn that same $2,500 in real estate rental income, you'd probably pay almost zero tax and keep most of that $2,500. That's cold, hard cash in your pocket that you can use to keep growing your portfolio. This is a hidden but absolutely huge benefit to real estate investing. The IRS just treats real estate differently from almost everything else. And almost anyone can use the US tax code to save on taxes and keep more for yourself. So today on the show, we're breaking down the many many ways real estate gets special treatment from the IRS and how you can use this to your advantage. I'm going to pull out the whiteboard and show you real examples and real numbers so you can start planning your next move. Speaker 1 (1:14) Hey, everyone. Welcome back to the BiggerPockets podcast. I'm Dave Meyer. Some benefits of real estate investing are obvious. Things like cash flow and appreciation and value-add investing. But some are a little more subtle. And today's show is about the biggest one of all of these subtle advantages, taxes. So today on the show, I'm going to break this thing down in detail. We're going to walk through several concrete examples with real numbers and show the different strategies you can use right now to optimize your tax situation. It's going to be fun. I think it's going to be eye-opening and it'll lower your tax bill. So let's do it. But before I get started, I'm going to use one single example, one deal for the entirety of this episode, just so you can follow the potential tax savings on a single deal. And then of course you can extrapolate that and how powerful this can be. for an entire portfolio. So I just kind of want to write out what my sample deal is to get things started. So for our deal, we're going to look at a property that we're going to purchase for $300,000. So it's a little bit below the national average, but as investors, this is the type of sweet spot I actually look for. I like to look for properties that are 125 to 150 a unit. So let's just assume that this is a duplex that we're going to be buying. Then we're going to put down payment. We're going to put 20%. We're going to get a mortgage at 7%. That's about where they're sitting today. For this property, our rent is going to be 2,800 bucks. And our operating expenses are going to be just under $12,000 a year. I actually ran the math and I figured it would be about $11,600. As we're going through this entire episode, remember that this is the deal that we're looking at. And if you actually calculate this out, I'm just gonna get to this now. Our cashflow for this deal would be about $2,840. And that comes out to a cash on cash return of 5%. So a solid deal in today's market, not a home run, not a bad deal. If you can get 5 % cash on cash return in most markets, you are doing very, very well. So let's just say that you find a great deal as we talk about how to do all the time on the podcast. And now you want to figure out how you can make this deal even better by optimizing your taxes. So the first tax strategy that you should be using, and this is probably the most common one, is known as depreciation. Depreciation is basically part of the tax code that allows you to deduct the gradual decline or deterioration of your property over time. In the IRS's eyes, everything out there, every physical object has a useful life. And for residential real estate, the government has decided the useful life for a house or a duplex or three unit. is 27.5 years. It's very specific, but they say that every 27 and a half years, you're going to need to essentially replace your property. And that decay over 27 and a half years is seen as a business expense that you can deduct in a given year. And this deduction counts against your rental income and lets you keep more cash flow. So let me just show you how this works. So remember that our income for this year, right, our profit or cash flow was $2,840. And if you were to pay your normal income on that, right, like if this was just regular income you got from your job, you might pay up to about 40 % in taxes, in which case you'd get $1,704 after tax. Still cash flow, right? Like that would still be money in your pocket, but it definitely lowers the return. Like you're no longer getting a 5 % cash on cash return. It's probably something like a three or three and a half percent cash on cash return. But luckily in our example, we're talking about rental income. And so what you do is subtract the depreciation. So you can take again that decay and subtract it from your income. And that's how much you pay in taxes. So let's figure out what the depreciation would be for our property. Now, an important distinction when you're figuring this out is that you do not get to depreciate the entire property. When your taxes are assessed, the tax assessment will have a land value and it will also have a building value. And so you need to know what this is. Usually it's like 80-20 building to land. Right, so I'm just gonna use that because this is just an example. So our land value here would be about $60,000 and our building value would be the remainder of our purchase price. So that would be $240,000. So all we gotta do now is take 240,000 and divide that by the oddly specific 27.5 years. And that gives us 8,000. $8,727. This is the amount, $8,727 is the amount that we can deduct from our rental income. So you take your $2,840, you subtract this $8,727, and that equals a negative $5,887. This is now, in the eyes of the IRS, That's your taxable income on your rental property. So instead of paying taxes on 2840, you are paying taxes on negative 5887, which is to say you are paying zero tax on your rental income. It's amazing, right? So like basically you're paying no tax on your rental income. Now, there are a few things I need to explain, a few caveats here. So first. You'll notice we're not using our total depreciation, right? We're only using a piece of it. We could deduct more than $8,000, but we only deducted $2,840. But we're going to get back to that. Remember that this was negative because we're going to talk about that in a couple of minutes. Second thing, just keep remembering that you depreciate the building value and not the land. So you can go, this is public data. You can go up and look at the land value versus the building value and only do this calculation on the building value. Third thing to remember is this is just residential property. If you're using a commercial property like large multifamily, you absolutely can still use depreciation, but commercial is depreciated over again, an oddly specific 39 years, not 27 and a half. And then there's the big one. This is really, really important. And it's something I think a lot of people forget about and miss is that eventually you do have to pay this tax. There is something when you go to sell your property called depreciation recapture, which is basically you paying this back eventually. And so if you're wondering, what does it matter? Why even do this if I am just going to repay it when you sell? Well, first and foremost, if you look at the time value of money, it says, I'm not going to totally get into this, but basically time value of money tells us that the current value of cash is more value than money in the future. So a dollar today is worth more than a dollar in 10 years. Why? Because you can invest that dollar today. And if you invested that and it compounds in 10 years, that dollar is probably going to be worth $2 or $2.50 or $3. And so having money now allows you to invest that over time. And so if you think about a rental property that you might own for 20 years, you just saved $2,840 that now you can compound for 20 years. And then when you go and sell your rental property 20 years from now, the depreciation recapture is probably going to be a drop in the bucket compared to all the appreciation you've had or the money that you've made compounding your savings on taxes. So this is absolutely still worth it with depreciation recapture. But