Long-Term Rentals: The Study Decision

Long-term residential rentals, leased for months or years to tenants, are the most common type of investment property. The study decision for these properties often turns less on the building and more on the owner's tax position. This page walks through the considerations.

Baseline facts

A long-term residential rental is generally depreciated over 27.5 years. It is generally treated as a passive activity for tax purposes, whether or not you are active in managing it, unless you qualify for real estate professional status and meet participation requirements for the activity. See Residential Rental Property and the 27.5 Year Class and The Passive Activity Loss Rules and Cost Segregation.

The main question is usability

For most long-term rental owners, the first question is not "how much could a study shift" but "can I use the resulting deductions." If your rental produces net taxable income before depreciation, additional depreciation can offset it. If it does not, the extra deduction could create a passive loss that is suspended unless you have other passive income or qualify for an exception. See Tax Bracket and Whether Deductions Are Usable.

The small landlord allowance

There is a limited allowance that may let some owners who actively participate deduct a portion of rental losses against other income, subject to income thresholds that phase the allowance out. The dollar amounts and thresholds are set by law. Higher earners generally do not qualify. Ask your preparer.

Real estate professional status

An owner who qualifies as a real estate professional and materially participates in rental activities can treat those rental activities as nonpassive. That can make losses usable. It is a demanding standard, and documentation matters. See Real Estate Professional Status and Study Decisions.

What a study may do for a typical rental

For a typical single-family or small multifamily rental, a study may identify some personal property and land improvements. The shift may be modest in dollar terms, in part because the building is often modest in size and the interior finishes are often standard. Whether it is worthwhile depends on the numbers. See Small and Low-Basis Properties.

Portfolio effect

If you own several rentals, some may generate income and others losses. A study on a property with a loss may add to that loss, while passive income from other properties may absorb it. A portfolio view can change the usability answer.

Hold period

Long-term rental investors often hold for many years. That favors the timing benefit if usable. But if you plan to sell within a few years, the recapture considerations apply. See Hold Period and the Decision.

Alternatives

Owners with smaller properties sometimes consider lighter approaches or simply depreciating purchased appliances and improvements separately. The trade-offs are discussed in Engineering-Based Versus Software-Only Studies.

What to gather

Purchase documents, prior returns, appliance and improvement receipts, and information about your income and participation. See How Long a Study Takes and What You Provide.

Risks

• Deductions might be suspended.
• The added compliance work may not be worth it.
• Recapture on sale.

Benefits, if they arise

• Earlier deductions against usable income.
• A detailed asset record.
• Possible catch-up for earlier years. See Catch-Up Depreciation With Form 3115.

A hypothetical

See Hypothetical: A Single Rental With Usable Deductions for a labeled hypothetical, and Hypothetical: Passive Limits and Suspended Losses for a case where the losses are limited.

Illustrative owners in words

An owner with one rental and a demanding full-time job outside real estate will typically find the rental passive and have limited ability to use additional losses. An owner with a portfolio of profitable rentals and modest depreciation may have passive income to absorb losses from a new property. An owner who has left a career to manage properties full time may qualify for real estate professional status, which changes the usability. Each of these owners faces a different decision even with the same building type.

The furnishing and appliance question

Long-term rentals are generally unfurnished, but do include appliances and sometimes window coverings. These items are depreciable, and if not separately tracked, may be buried in the building's basis. Ask your preparer whether items you purchased after acquisition are on your schedule as separate assets.

Rate of return and reinvestment

If you receive earlier tax savings, consider what you will do with them. Paying down debt, funding repairs, or holding reserves can be sensible. Simply having a larger refund is not in itself a benefit unless it improves your financial position.

A cautious summary

For many long-term rental owners, usability and property size decide the matter. Where those are favorable, a study is worth a look. Where they are not, it is often reasonable to skip.

What if your situation changes

If you become a real estate professional or your income falls in a later year, a study that was not attractive may become attractive. Keep the records and the decision note so that you can revisit quickly.

A quick checklist

Confirm whether your losses would be usable. Confirm building basis. Confirm hold period. Confirm quotes. Confirm your preparer's comfort with the position. If usability fails, decide whether to skip or wait.

Next steps

Work through the Cost Segregation Decision Checklist, with special attention to usability.