If you took the plunge into buying an investment property, you probably did so intending to generate passive income. However, the demands of military life, coupled with challenging real estate market trends, can make it difficult to create opportunities for additional income. But don’t lose your optimism. When handled well, a rental property is an excellent long-term source of profit.
Keep in mind that just as your primary source of income is taxable, so is your rental income. The good news is that your transactions with the IRS aren’t as straightforward as they might appear, and some rules and deductions can work in your favor.
Below is a streamlined look at what's taxable and which deductions may help preserve the profits from your real estate investment properties.
1. What the IRS Considers Taxable
Rental income includes more than just the monthly rent. Common taxable items include advance rent (such as first and last month’s payments), non-refundable deposits, fees paid by tenants to break a lease, and even services performed in lieu of rent. For example, if your tenant paints the exterior of the home in exchange for two months of rent, you must claim the value of those two months as income.
Security or pet deposits are only taxable when you keep part or all of the funds to cover damages. If you plan to return them at the end of the lease, you don’t need to claim them as income for the year received.
Are you considering a VA loan for investment properties? Is a Rental Property the Right Investment for You? can help you decide.
2. The Parts of Your Real Estate Investment That Are Tax Deductible
Rental property owners benefit from a variety of deductions. In fact, many properties qualify as a "trade or business" under the IRS safe harbor for the Qualified Business Income (QBI) deduction, opening the door to additional tax advantages.
Depreciation
Rental property owners who earn income may use depreciation to deduct some costs invested in a rental property to maintain its usefulness. Most often, the modified accelerated cost recovery system (MACRS) is used to calculate the depreciation of residential rental properties. The IRS also uses Schedule E to report depreciation.
In the most basic sense, this means that you take the tax assessor's appraisal and divide it by 27.5 for your depreciation deduction. Use the following scenario as an example.
For instance, say that you paid $200,000 for your rental property. The tax assessment for the land is $75,000, and for the building is $125,000. To calculate depreciation for rental property purposes, you’d simply divide $125,000 by 27.5 to get your depreciation expense of $4,545 multiplied by your marginal tax rate each year.
Depreciation can get complicated, so it’s best to hire a tax professional for help.
Interest
Mortgage interest and interest on loans used for improvements or rental-related purchases are deductible, including credit-card interest tied to rental expenses.
Pass-Through Deduction
Landlords who operate as a sole proprietor, LLC, or partnership may qualify for up to a 20% pass-through deduction, provided the rental generates profit, and the owner has positive taxable income. (I.R.C. § 199A (2025))
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Travel
Long-distance landlords can benefit from this. Since the IRS treats real estate investments like businesses, travel costs associated with maintaining the property are tax-deductible.
That means that all or portions of airfare, hotels, meals, gas, car rental, or mileage can help you get a tax break. Keep records of your receipts.
Legal Fees and Professional Services
Property-management fees, accountant costs, legal fees, and investment-adviser expenses generally count as operating expenses.
Ordinary and Necessary Expenses
It takes time and money to keep a rental property up and running. Thankfully, many of these expenses are deductible.
These include marketing, cleaning and maintenance, HOA fees, property taxes, utilities you cover, repairs, materials, and insurance deductibles. Essentially, if it keeps the rental functioning, it may qualify.
Repairs and Improvements
While repairs and improvements made to the property are tax deductible. There are a couple of different ways to claim them. If they’re minor and add little value to the home, you can deduct them the same year you make them.
If the improvements are major, such as renovations or a new roof that add substantial value to the home, you will add the expense to the home’s cost basis and treat it as part of the annual depreciation deduction.
If you expect to sell soon, Important Tax Matters for Military Families When Selling or Renting a Home covers additional considerations, regardless of real estate market trends.
3. How to Avoid a Tax Hit When Selling Your Rental Property
When it's time to sell, your goal is to walk away with as much financial growth as you can. That starts with understanding depreciation recapture and capital gains.
Depreciation Recapture
While depreciation can provide a bit of a tax break, there’s a less fortunate side to the equation. Depreciation lowers your taxable income while you own the property, but the IRS "recaptures" the value when you sell.
For example, you bought the property for $150,000 and are selling for $200,000. Over the last several years, you claimed $7,000 in depreciation deductions. The $50,000 you make from the sale is considered a capital gain, which is taxable and also known as capital gains tax. And the $7,000 you deducted falls under taxable income.
Capital Gains Taxes—and How to Reduce Them
Capital gains are what you’ve been working for and served as the light at the end of the tunnel. And, if you play your cards right, it’s a nice chunk of money. A few strategies may help soften the impact of taxes on capital gains.
Make the Rental Property Your Primary Residence
You might already know that when you sell a primary residence, you gain the opportunity to exclude up to $500,000 from the capital gains. See The Effect of Capital Gain Tax Exclusion on Military Home Sellers for more details and eligibility.
This means that if you can turn your rental property into a primary residence long enough to meet the capital gains tax exemption requirements, you could walk away with a larger profit. However, this measure can be hard to pull off if you’re active-duty military.
Use a 1031 Exchange
Section 1031 allows you to defer the capital gains tax from one rental sale if you reinvest your profits into another investment property.
Try Tax-Loss Harvesting
Tax-loss harvesting allows you to pair the gain from your home sale with the loss on other investments. Tax-loss harvesting is complex, and it's highly recommended to consult with a professional.
While it's important to understand taxes associated with your rental property, a trained accountant will help ensure that you not only get the most out of your investment but also stay within the bounds of tax laws.
See Military PCS Move: How to Handle Taxes When Selling Your Rental for more details about investment property taxes.
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