Tax Guide

Why your profitable rental has a tax loss

Calculating deductions

Your rental property puts cash in your pocket every month. But on your tax return, it shows a loss. This isn't a mistake — it's depreciation, and it's the single most powerful tax benefit available to rental property owners. Most landlords underestimate it. Some don't even know it exists.

What is rental property depreciation?

The IRS considers that buildings wear out over time. Even if your property is appreciating in market value, the tax code lets you deduct a portion of the building's cost each year as a “depreciation expense.” This is a non-cash deduction — you don't write a check for it, but it reduces your taxable rental income.

For residential rental property, the IRS requires straight-line depreciation over 27.5 years. The formula is simple:

Annual depreciation

(Property value × building ratio) ÷ 27.5

The IRS requires you to separate land from building value. Land is not depreciable. A common split is 80% building / 20% land, though the actual ratio depends on your local market and appraisal.

A worked example: cash-flow positive, tax-loss negative

Say you own a rental property worth $350,000 that brings in $2,500/month in rent.

Cash flow (what hits your bank account)

Annual rent$30,000
Mortgage payment (P+I)−$18,000
Expenses (taxes, insurance, repairs)−$8,000
Net cash flow+$4,000

Tax return (what the IRS sees)

Annual rent$30,000
Mortgage interest only(principal is not deductible)−$12,000
Expenses (taxes, insurance, repairs)−$8,000
Depreciation($350K × 80% ÷ 27.5)−$10,182
Net rental loss−$182

You pocketed $4,000 in real cash, but your tax return shows a $182 loss. Depreciation created that gap. And that's with a modest $350K property — higher-value properties generate proportionally larger paper losses.

A $500K property generates ~$14,545/yr in depreciation. A $750K property generates ~$21,818/yr.

The more your properties are worth, the larger the paper loss — and the more valuable REPS or STR qualification becomes.

What can you do with a rental loss?

This is where it gets interesting — and where most landlords leave money on the table. What you can do with the loss depends on your tax situation:

Path 1: No qualification (most landlords)

Rental losses are classified as passive under IRC §469. They can only offset other passive income. The one exception: if your AGI is under $150K, you can deduct up to $25,000 in rental losses against active income (§469(i) special allowance). This phases out linearly between $100K and $150K AGI. Above $150K, it's $0.

Unused losses carry forward until you either have passive income to offset or sell the property.

Path 2: Real Estate Professional Status (REPS)

If you document 750+ hours per year in real property trades or businesses, and spend more time in real estate than any other job, your rental losses become non-passive. They can offset W-2 wages, business income, and any other active income with no dollar cap.

This is where depreciation becomes powerful. A $10K paper loss at a 37% marginal rate saves $3,700 in real taxes.

Path 3: Short-Term Rental (STR) loophole

If your average guest stay is 7 days or less, the rental is not a “rental activity” under IRS rules. With material participation (100+ hours and more than anyone else), losses are non-passive — no REPS required.

The pattern is clear: depreciation creates the loss, but hours unlock it. Without documented hours, the loss sits on your return doing nothing. With documented hours, it directly reduces your tax bill.

What most landlords get wrong about depreciation

“My property is going up in value, so I can't depreciate it.”

Wrong. Depreciation is based on the building's cost basis, not its market value. A property appreciating in value still depreciates on your tax return. The IRS requires you to take the deduction even if you don't want to (you'll be taxed on depreciation recapture when you sell regardless).

“I can't use the loss because I make too much money.”

That's only true if you're relying on the $25K passive allowance, which phases out above $100K AGI. With REPS or the STR loophole, there is no income limit. In fact, the higher your income, the more valuable the deduction — a loss worth $5,000 at a 24% rate becomes worth $8,450 at 37%.

“Depreciation will hurt me when I sell.”

Depreciation recapture is taxed at 25% when you sell. But you owe it whether you took the deduction or not — the IRS taxes “depreciation allowed or allowable.” You're better off taking the deduction now, getting the time value of that money, and deferring the sale through a 1031 exchange if you want to avoid recapture entirely.

“I only have one property, so depreciation doesn't matter.”

A single $350K rental generates over $10,000 in annual depreciation. Combined with mortgage interest and expenses, that's often enough to create a meaningful paper loss. REPS is harder to achieve with one property (documenting 750 hours requires ~15 hours/week), but the STR loophole only requires 100 hours.

See your numbers

Our tax savings calculator models this exact relationship. Enter your properties, hours, and income — it computes depreciation, calculates your rental loss, checks REPS/STR qualification, and shows how much you could save. Every input is adjustable, so you can see exactly how changing one variable (adding a property, working five more hours a week, switching to STR) shifts the outcome.

Try the calculator

Depreciation creates the loss. RE:Writeoff proves the hours.

The math is straightforward — depreciation plus expenses minus rent equals a loss. The hard part is proving to the IRS that you qualify to use it. That means a contemporaneous log of your property management hours, maintained throughout the year, with evidence tied to each entry.

RE:Writeoff captures that documentation automatically. Emails to contractors, vendor invoices, tenant messages, maintenance requests — they all become timestamped, categorized entries in your activity log. When your CPA needs proof of REPS qualification, you export the report. When the IRS asks for documentation, you hand over evidence-backed records instead of a spreadsheet you filled in from memory.

RE:Writeoff is a documentation tool and does not provide tax advice. Consult a qualified tax professional for advice specific to your situation.

References

Stop leaving depreciation on the table.

RE:Writeoff documents the hours that unlock your rental losses. 30-day free trial, no credit card.

Start free trial
Why Your Profitable Rental Has a Tax Loss — Depreciation Explained | RE:Writeoff | RE:Writeoff