Listing remarks
- The IRS lets landlords recover the cost of a residential rental building through depreciation over 27.5 years; land is not depreciated.
- Investor.gov says non-traded REITs are illiquid and generally cannot be sold readily on the open market.
- Up to $25,000 of rental losses can offset other income for landlords who actively participate, phasing out between $100,000 and $150,000 of modified adjusted gross income.
Real estate attracts investors for good reasons, and it also ruins some of them. The same features that make it appealing, such as borrowed money and a physical asset you control, are the ones that can hurt when things go wrong. Here is a balanced look, side by side.
The advantages
Income from rent
A rental property can produce regular income. The IRS treats rent as ordinary income, and it counts more than the monthly check: advance rent, fees a tenant pays to cancel a lease, and the part of a security deposit you keep are all rental income, according to Publication 527.
Tax deductions, including depreciation
Landlords can deduct ordinary and necessary expenses such as mortgage interest, property tax, insurance, repairs and management. They can also deduct depreciation, which spreads the cost of the building, but not the land, over its recovery period. For residential rental property that period is 27.5 years under the general depreciation system. Depreciation is a paper expense, so a property can show a tax loss while still producing cash. More in Rental Property Taxes: Income, Deductions, Depreciation and Losses.
A limited break on losses
Rental losses are generally passive, which limits how much can offset wages. But the IRS allows up to $25,000 of loss from rental real estate against other income if you actively participate, meaning you own at least 10 percent and make management decisions. The allowance shrinks once modified adjusted gross income passes $100,000 and is gone at $150,000 (half those amounts for married filing separately).
Control
With direct ownership you choose the property, set the rent within the law, decide on improvements and pick the manager. Few other investments offer that.
Leverage
Most buyers borrow. Leverage means a modest down payment controls a much larger asset. If the property rises in value, the gain on your own cash is magnified. That cuts both ways, as the next section shows.
Deferral when you trade up
Section 1031 lets you defer tax on gain when you exchange investment real property for other like-kind real property, if strict timing rules are met. See 1031 Exchanges Explained: Deferring Tax When You Trade Up.
The disadvantages
Leverage magnifies losses too
A loan has to be paid whether or not the unit is rented. If the value falls, your equity shrinks faster than the price. Lenders know this, which is why Fannie Mae prices investment property loans higher than loans on a home you live in and generally wants six months of payments in reserve.
Illiquidity
Selling a building takes time and costs money. Indirect investments are not always easier: the SEC’s Investor.gov warns that non-traded REITs generally cannot be sold readily on the open market, and Regulation Crowdfunding investments usually cannot be resold for the first year.
Concentration
One rental house is one bet on one street. A vacancy, a bad tenant or a failed furnace can wipe out a year of profit. A stock index fund spreads risk across hundreds of companies; a single property cannot.
It is a job
Tenants call at night. Landlords must follow fair housing law, lead disclosure rules for older housing and state landlord-tenant law. You can hire a manager, but the fee comes out of the rent and the legal responsibility stays with you. See Landlord Rules Every New Investor Should Know: Fair Housing and Lead Paint.
Taxes catch up later
Depreciation lowers taxes while you own the property, but it reduces your basis. When you sell, the IRS says the unrecaptured section 1250 gain from depreciation on real property is taxed at a maximum 25 percent rate, and any remaining long-term gain is taxed as a capital gain.
Scams target beginners
The FTC warns that real estate investment training often promises easy profits and delivers expensive upsells. Real Estate Investment Scams: Seminars, Coaching and Too-Good Deals explains the warning signs.
Side by side
| Feature | Upside | Downside |
|---|---|---|
| Rent | Regular income | Vacancies and non-payment |
| Borrowing | Small cash controls a large asset | Losses magnified; payments due regardless |
| Depreciation | Lowers taxable rental income | Reduces basis; recaptured at sale |
| Control | You make the decisions | You carry the legal duties |
| Selling | 1031 can defer tax | Slow and costly to exit |
Who it tends to suit
Direct ownership tends to suit people with steady income, cash reserves beyond the down payment, time or money for management, and a long horizon. Someone who wants real estate exposure without the work may prefer a publicly traded REIT, while accepting that its price moves with the market. Start with How to Start Investing in Real Estate: A First-Timer’s Roadmap if you have not chosen a path yet.
The bottom line
Real estate can provide income, tax advantages and long-term growth, but it ties up money, concentrates risk and comes with legal obligations. Weigh both columns honestly, and run your own numbers before you decide.