First-year setup: basis and the land split
Your starting point is basis: purchase price plus most closing costs, allocated between land and building, because land does not depreciate. The county assessor's land-to-improvement ratio is a common and defensible allocation method. Depreciation begins when the property is placed in service, meaning ready and advertised for rent, not when the first tenant signs. Getting these numbers right in year one matters because every later year, and the eventual sale, is computed from them.
Income and expenses
Rents received are ordinary income. Common deductions: mortgage interest, property tax, insurance, repairs, maintenance, property management fees, depreciation, and travel to the property for business purposes. Security deposits are not income while refundable, and prepaid rent is income when received. Expenses paid by the tenant on your behalf count as rent to you.
Depreciation
Residential rentals depreciate straight-line over 27.5 years. Commercial over 39. Land isn't depreciable; allocate purchase price between land and improvements. Taken depreciation must be recaptured at up to 25% on sale. The recapture applies to depreciation you were allowed to take even if you never claimed it, which is why skipping depreciation is the worst of both worlds: no deduction now, full recapture later. Missed years can be fixed with an accounting method change rather than amending each return.
Passive activity loss rules
Rental losses are passive by default. Passive losses offset only passive income, not W-2 or active business income. Losses not used in the current year carry forward. Suspended losses are not lost; they accumulate and release in full when the property sells in a taxable sale, which often shelters a large slice of the gain in the exit year.
The $25,000 active participation exception
If you actively participate (approve tenants, make management decisions) and your AGI is under $100,000, you can deduct up to $25,000 of rental losses against other income. Phases out to zero at $150,000 AGI. Active participation is a low bar; using a property manager does not break it as long as you still make the meaningful decisions.
Real Estate Professional status
Spending 750+ hours per year AND more than half your working hours in real estate trades removes the passive loss limitation. Documenting hours is the compliance challenge. A full-time W-2 job in another field makes the more-than-half test nearly impossible, so in two-earner households the status usually runs through the spouse whose work is actually in real estate. Keep a real time log; reconstructed hours are the losing pattern in these audits.
Short-term rentals
STRs with average stay under 7 days escape passive classification entirely if you materially participate. Losses fully offset W-2 income. This is one of the biggest tax levers in real estate. Material participation has its own hour tests, and in Florida a short-term rental also carries sales tax and local tourist development tax obligations on the rental charges, which are separate from the income tax side.
Repairs vs improvements
Repairs are current-year deductible. Improvements are capitalized and depreciated. The line is blurry, we document and defend under the tangible property regulations. Fixing a leak is a repair; replacing the roof is an improvement. The safe harbors in the regulations (de minimis, small taxpayer, routine maintenance) let many mid-sized expenditures be deducted currently when the paperwork is set up correctly at filing time.
Selling: recapture, exclusions, and 1031 exchanges
A taxable sale triggers capital gain on the appreciation plus recapture on the depreciation, and releases any suspended passive losses. A 1031 exchange defers the whole gain by rolling into another investment property, under strict deadlines: 45 days to identify replacements and 180 days to close. A former primary residence converted to a rental may retain a partial Section 121 exclusion if sold within the qualifying window, which changes the sell-versus-exchange math considerably.
Common questions
- Can I deduct my mortgage down payment?
- No. The down payment becomes part of your basis in the property, not a deduction.
- What if I use the rental myself part of the year?
- Mixed-use property rules limit deductions. More than 14 days personal use or 10% of rental days triggers vacation home rules.
- Do I need an LLC for my rental property?
- That's a liability question, not a tax one. A single-member LLC is disregarded for federal tax, so the Schedule E looks identical either way. Talk to an attorney about the protection side; the tax return doesn't change.
- My AGI is over $150,000 and my rental shows a loss. Is it wasted?
- No. The loss suspends and carries forward, offsetting future rental profit, other passive income, or the gain when you eventually sell.
- What records do I need to keep, and for how long?
- Closing statements, improvement invoices, depreciation schedules, and annual income and expense records. Basis documents should be kept until several years after the property sells, because the sale calculation reaches all the way back to the purchase.
More guides
2025 Federal Tax Brackets
Complete 2025 federal tax brackets for single, MFJ, MFS, and HoH filers, plus standard deduction amounts and how marginal rates actually apply to your income.
Standard vs Itemized Deductions
2025 standard deduction: $15,000 single, $30,000 MFJ, $22,500 Head of Household. When itemizing wins and how the bunching strategy stacks charitable giving.
What to Bring to Your Tax Appointment
The exact documents we ask for before a tax appointment: photo ID, W-2s, 1099s, K-1s, and deduction records. Pair with our downloadable tax prep checklist.
The Complete Guide to Self-Employment Taxes
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