Real estate has long been a favored investment for building wealth, but what many investors overlook is how much of that wealth can be preserved—or lost—through smart tax planning. From depreciation and expensing rules to capital gains strategies and deferral opportunities, the tax code offers a range of powerful tools for real estate owners.

Understanding how these rules work can mean the difference between a modest return and a significantly enhanced after-tax profit. In this article, we’ll explore key tax concepts that every real estate investor should know to make informed decisions and maximize their tax savings.

Depreciation Basics

Residential rental property is depreciated over 27.5 years, while commercial property is depreciated over 39 years. However, not all real estate is eligible for depreciation. Land itself never depreciates—only the buildings or improvements on top of it do. If you’re buying personal property—things like equipment or furnishings that aren’t part of the real estate—those typically depreciate faster and can benefit from more aggressive write-offs like bonus depreciation and Section 179 expensing.

Bonus Depreciation & Section 179 Expensing

Section 179 allows you to immediately expense certain qualifying assets in the year they are placed in service, up to a limit of $1,250,000 in 2025, with the deduction beginning to phase out when total asset purchases exceed $3,050,000.

Bonus depreciation, on the other hand, permits an immediate deduction of a large percentage of the cost of eligible property — currently 40% in 2025 as it continues to phase down from its previous 100% rate.

Both provisions can offer substantial upfront tax savings, but they are generally limited to personal property, land improvements, and certain shorter-lived components of a building, not the building itself.

Accelerated depreciation is especially attractive for those with high income in the year of acquisition or renovation.

Cost Segregation Studies

One advanced tax strategy in real estate is a cost segregation study. This process breaks down the purchase price of a property into separate components so that personal property and land improvements can be depreciated faster than the building itself. A cost segregation study can often be done even after a property has already been purchased. Although the study can be expensive and doesn’t always make sense—especially if you expect to sell the property soon—it can unlock significant cash flow through accelerated depreciation.

Depreciation Recapture

That brings us to a key caution: depreciation recapture. When you sell a depreciated property, the IRS wants to claw back some of the tax benefit you’ve previously received. This recaptured depreciation is taxed at a maximum rate of 25 percent or your ordinary income tax rate, whichever is lower. It’s not quite as bad as ordinary income tax in most cases, but it’s definitely worse than capital gains tax, so careful planning is essential.

Repair or Improvement?

Another area of concern is distinguishing between repairs and improvements. Repairs, like fixing a leaky faucet or patching a roof, are generally deductible right away. Improvements, on the other hand, enhance the property or extend its useful life and must be depreciated. If you’re unsure, the IRS offers a few safe harbors—like the small taxpayer safe harbor and the routine maintenance rule—to help you categorize costs correctly. Improvements typically include betterments, adaptations to a new use, or restorations, and may also apply to major upgrades of an entire system, such as replacing all HVAC units in a building.

Like-Kind Exchanges

When it’s time to part with a property, a 1031 exchange might allow you to defer taxes entirely. By using a qualified intermediary to sell one property and buy another of like kind, you can carry over your tax basis and defer capital gains and depreciation recapture. This process is full of rules and deadlines, so don’t attempt it without professional guidance.

Primary Residence Exclusion

If you’re selling your primary residence, the rules are different. You may qualify to exclude up to $250,000 of gain, or $500,000 for married couples, provided you’ve lived in and owned the home for two of the past five years. That exclusion, however, doesn’t apply to depreciation you’ve previously claimed—so even on your residence, some tax may be due.

Step-up in Basis

On the other hand, the most tax-efficient exit strategy might be to never sell at all. If you hold your real estate until death, your heirs receive a step-up in basis to the property’s fair market value at the date of your death. This resets the depreciation clock and eliminates accumulated gains and recapture—one of the few remaining loopholes that truly wipes out tax liability.

Real Estate Professional Status (REPS)

Real estate professional status is one of the most valuable tax designations available to active real estate investors, but it’s also one of the most misunderstood.

Under the IRS rules, rental real estate activities are generally considered passive, meaning that any losses they generate can only offset other passive income—not wages or business income. However, if you qualify as a real estate professional, your rental losses may be treated as non-passive, allowing you to deduct them against ordinary income such as salary or self-employment earnings.

To qualify, you must materially participate in your rental activities and spend more than 750 hours per year—and more than half of your total working hours—on real estate trades or businesses in which you materially participate. This includes development, construction, acquisition, management, leasing, and brokerage, but not simply owning rental properties as a passive investor. Married couples can qualify based on the participation of just one spouse, which opens up planning opportunities for households with a stay-at-home partner or flexible work schedules.

Proper documentation of hours and activities is critical, as the IRS often scrutinizes real estate professional claims closely. When done correctly, achieving this status can unlock major tax savings and transform the economics of your real estate portfolio.

Final Thoughts

Real estate taxation is full of powerful tools and costly traps. The key is to plan before you buy, keep excellent records, and think long-term. With the right strategy, your real estate investments can become a tax-efficient engine for building wealth.