Key Takeaways
- December 31 is a hard deadline; once the year closes, most real estate tax planning options are no longer available.
- Review repair and improvement spending, depreciation elections, and cost segregation opportunities before year-end, as timing directly affects what is deductible.
- Passive activity loss rules, AGI thresholds, and California’s nonconformity with federal law all affect how and when rental losses can be used.
- Sale, exchange, hold, and installment sale decisions carry very different tax consequences; structure matters, and those decisions should be made before a contract is signed.
For real estate investors, the final months of the year are an important planning window. By December 31, many tax outcomes are already locked in. However, there may still be time to make decisions about acquisitions, dispositions, repairs, depreciation, passive losses, entity planning, and cash flow. For more information on tax planning for next year, be sure and check out What Your 2025 Tax Return Is Telling You About 2026.
Whether property is owned directly, through a partnership, or through an LLC taxed as a partnership, year-end planning can help investors align tax results with investment goals.
Review current-year income and loss projections
The first step is to estimate taxable income or loss from each property and each entity. Investors should compare expected rental income, operating expenses, interest expense, depreciation, capital improvements, and debt activity.
A projection can help answer important questions:
- Will the property generate taxable income or a loss?
- Are losses currently deductible, or will they be suspended?
- Is the taxpayer close to an AGI threshold that affects rental loss deductibility?
- Will a refinancing, sale, or distribution affect basis?
- Are partners receiving enough cash to cover their tax liabilities?
This review is especially important for partnership-owned real estate. Partners may be allocated taxable income even when cash is retained for debt service, reserves, or future improvements.
Evaluate repairs, maintenance, and capital improvements
Before year-end, real estate investors should review spending on repairs, maintenance, renovations, and improvements. The tax treatment can vary significantly depending on whether an expenditure is currently deductible or must be capitalized and depreciated.
Items to review include:
- Routine maintenance
- Unit turnovers
- Roof, HVAC, plumbing, electrical, and structural work
- Tenant improvements
- Common area improvements
- Furniture, fixtures, and equipment
- Parking lots, landscaping, and other land improvements
Good documentation is critical. Invoices, contracts, photos, and project descriptions can help support the tax treatment of expenditures.
Consider cost segregation opportunities
A cost segregation study may help identify building components that can be depreciated over shorter recovery periods. Real property is generally depreciated over 27.5 years for residential rental property or 39 years for commercial property, but certain components may qualify as shorter-lived property. Cost segregation can help allocate building costs to the appropriate asset classes, including property that may qualify for accelerated depreciation methods.
Cost segregation may be worth considering when a taxpayer has:
- Purchased a building
- Completed a major renovation
- Constructed a new property
- Converted a property to a new use
- Significant taxable income that may be offset by depreciation deductions
Review bonus depreciation and Section 179 planning
Real estate investors should review whether assets placed in service before year-end qualify for bonus depreciation or Section 179 expensing. Certain building components, land improvements, equipment, furniture, fixtures, and qualified improvement property may be eligible depending on the facts.
Section 179 and bonus depreciation have different rules. Section 179 is subject to limitations, including taxable income limits, while bonus depreciation is not subject to a taxable income limitation. Qualified property and placed-in-service timing should be reviewed carefully.
Planning points include:
- Confirming when property is actually placed in service
- Identifying which assets qualify for accelerated deductions
- Reviewing state conformity, since state depreciation rules may differ
- Evaluating the effect on partner basis and capital accounts
- Considering whether deductions will create or increase suspended losses
Plan for passive activity limitations
Many rental real estate losses are subject to the passive activity loss rules, so deductions may be limited and unused losses may be suspended. Participation level matters. Under IRC Section 469(c)(7), certain real estate professionals may treat rental real estate activities as nonpassive if they meet the required time and material participation standards.
Rental real estate loss treatment generally depends on the taxpayer’s level of participation. Passive rental ownership is the default, meaning losses generally offset only passive income and unused losses are suspended. Active participation is a lower standard than material participation and may allow the IRC Section 469(i) special rental real estate allowance of up to $25,000 against nonpassive income, subject to the modified AGI phaseout beginning at $100,000 and fully phased out at $150,000. This allowance does not apply to every rental owner and is not the same as real estate professional treatment.
Material participation is a separate standard relevant to qualifying real estate professionals under IRC Section 469(c)(7). If the taxpayer meets both the real estate professional tests and the material participation requirements, rental losses may be treated as nonpassive for federal purposes without relying on the $25,000 allowance. California adds another layer because it generally follows the federal passive activity loss rules but does not conform to IRC Section 469(c)(7). As a result, a rental real estate activity that is nonpassive federally for a qualifying real estate professional may still be passive for California purposes, and California Form FTB 3801 may be needed to compute California passive activity loss differences.
Helpful year-end action steps include:
- Updating time logs for real estate activities
- Reviewing whether activities should be grouped or treated separately
- Estimating current-year AGI
- Reviewing suspended passive loss carryovers
- Considering whether a sale or disposition may free up suspended losses
Revisit sale, exchange, or hold decisions
Investors considering a sale should evaluate tax consequences before signing a contract. The best structure may depend on gain, depreciation recapture, suspended losses, debt, replacement property plans, and cash needs.
IRC Section 1031 can allow deferral when real property held for investment or business use is exchanged for qualifying replacement real property. Only real property held for use in a trade or business or for investment qualifies for tax-deferred like-kind exchange treatment.
An installment sale may also be considered when at least one payment will be received after the year of sale. Under IRC Section 453, gain may generally be recognized as payments are received, subject to applicable limitations.
A fully taxable sale may sometimes be preferable, especially where suspended passive losses can be released. Suspended passive activity losses are generally deductible when the taxpayer disposes of the entire interest in the passive activity to an unrelated party in a fully taxable transaction
Before year-end, investors should compare:
- Taxable sale
- Installment sale
- Like-kind exchange
- Holding the property into a later year
Each option can produce a different result for cash flow, taxes, basis, depreciation, and estate planning.
Review partnership and LLC tax items
Many real estate investments are owned through LLCs taxed as partnerships. Year-end is a good time to review whether the entity’s tax records and operating agreement still match the economics of the deal.
Items to review include:
- Capital account balances
- Partner basis schedules
- Liability allocations
- Debt guarantees
- Preferred returns and special allocations
- Distributions and draw policies
- Section 754 election considerations
- Authority to make tax elections
LLC operating agreements should address tax elections and who has authority to make them, since missing election deadlines can create avoidable tax problems.
This review is especially important if there has been a partner buyout, ownership transfer, refinancing, property distribution, or death of a partner.
Make the planning window count
Real estate tax planning works best before transactions are completed and before the year closes. Once December 31 passes, many options become limited.
Investors should consider a year-end review if they have purchased, sold, refinanced, renovated, or exchanged property during the year, or if they expect significant changes in income, ownership, or debt. A focused planning conversation can help identify opportunities, avoid surprises, and align tax decisions with long-term investment goals.
