Tax Help for Real Estate Investors and Landlords

Real estate can build wealth, but the tax rules reward investors who plan for them and punish those who guess. Depreciation lowers current tax and increases tax later. Passive loss limits can trap deductions. Short-term rentals sit under different rules than long-term leases. This page walks through the issues most landlords and investors in Naperville, Aurora, DuPage and Will counties, and those investing from other states or from India, should understand.

Reporting rent and depreciation

Most rental income and expenses go on Schedule E. Deduct mortgage interest, property taxes, insurance, management fees, repairs, utilities and depreciation. Real estate taxes on a rental are a business expense on Schedule E, so they are not subject to the cap that limits state and local tax deductions on Schedule A. A refundable security deposit is not income when received; if you keep it because the tenant breached the lease, it becomes income in that year.

Residential rental property is depreciated over 27.5 years using the straight-line method, and the building is separated from the land, which is not depreciable. Improvements must be capitalized, while repairs are generally deductible; the de minimis safe harbor lets you deduct many items of $2,500 or less per invoice item. Depreciation reduces your basis whether or not you claim it, so missing it does not save tax later. See rental property taxes.

Passive losses and real estate professionals

Rental activities are generally passive. Passive losses can offset passive income, but not wages. If you or your spouse actively participate, which requires at least a 10 percent ownership interest, you may deduct up to $25,000 of rental loss against other income. That allowance is reduced by 50 percent of modified AGI above $100,000 and is generally gone at $150,000 (Publication 925). Disallowed losses carry forward on Form 8582 and are released when you sell your entire interest.

A real estate professional escapes the passive label if more than half of personal service time is in real property trades or businesses in which you materially participate, and you perform more than 750 hours in them. The IRS looks for contemporaneous time logs, not estimates. Net rental income is also potentially subject to the 3.8 percent net investment income tax when modified AGI exceeds $200,000 ($250,000 joint) unless the rental is an active trade or business; see net investment income tax.

Short-term rentals

If the average period of customer use is 7 days or less, the activity is not a rental activity under the passive rules, so the material participation tests apply, such as more than 500 hours of participation. If you provide significant services, such as maid service, the income belongs on Schedule C and is subject to self-employment tax. Providing heat, light, trash collection and cleaning of public areas is not a significant service (Schedule E instructions).

Illinois adds its own tax. The Hotel Operators' Occupation Tax applies to renting sleeping rooms for fewer than 30 consecutive days, and Illinois says it covers short-term rental hosts and intermediaries such as property managers and marketplace facilitators. Cities and counties may also impose lodging taxes. If you rent your own home for fewer than 15 days in a year, the rent is generally not income and related costs are not deductible (Publication 527).

Selling, exchanging and depreciation recapture

Long-term capital gains are taxed at 0, 15 or 20 percent depending on taxable income; for 2025 the 15 percent rate starts above $96,700 of taxable income for joint filers. The part of gain attributable to depreciation on real property, called unrecaptured section 1250 gain, is taxed at up to 25 percent. A Section 1031 like-kind exchange can defer the gain on real property held for investment or business use if strict identification and closing rules are met and a qualified intermediary holds the funds. See like-kind exchanges before you sign a contract, since a missed step cannot be fixed later.

Cost segregation and bonus depreciation

A cost segregation study separates components such as flooring, fixtures and site improvements into shorter depreciation lives. Property acquired after January 19, 2025 qualifies for 100 percent bonus depreciation. The benefit may be limited if losses are passive, and recapture applies on sale. The IRS has published an audit technique guide, so documentation matters. See cost segregation.

For the 20 percent qualified business income deduction, a rental enterprise may qualify as a trade or business under the IRS safe harbor in Revenue Procedure 2019-38. Beginning in 2026, the new minimum QBI deduction requires an active business, which means material participation.

Out-of-state, Illinois and India-linked investors

A nonresident who owns Illinois rental property must file an Illinois return with Schedule NR if the Illinois income creates a tax liability. Foreign owners, including nonresident Indians, face withholding on rent and on sale, plus special filing rules; read our guide for NRIs investing in U.S. real estate. U.S. residents who also own property in India should see rental income from India.

Records and red flags

Keep closing statements, loan documents, receipts for improvements, leases, mileage to properties, 1099s to contractors and a log of your hours. Red flags include rental losses used against wages without meeting the professional test, personal use of a rental, repairs that look like improvements, unreported cash rent, and depreciation mistakes.

How we can help

We prepare rental and partnership returns, evaluate passive loss and real estate professional positions, coordinate cost segregation and 1031 exchanges with your advisors, and handle Illinois filings. See real estate investor tax and tax planning. This page is general information, not advice for your situation.

Frequently asked questions

General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.