Taxes and tax filing for real-estate investment: how to use expenses, depreciation, and loss offsetting
Income earned from real-estate investment (rental management) must be filed as "real-estate income." A distinctive feature is that you can deduct many expenses — in particular, using "depreciation," an expense where no cash actually goes out, to create a loss on paper that can be offset against your salary income (loss offsetting).
The formula for real-estate income
Total revenue includes rent, key money (non-refundable), common-area fees, parking fees, and the like[National Tax Agency No.1370].
Main expenses you can deduct against real-estate income
Fixed asset tax and city planning tax
Taxes levied on the real estate as of January 1 each year are fully deductible.
Management fees and repair costs
Fees to a management company (roughly 5–10% of rental income) and repair costs are fully deductible. However, large-scale renovations that raise the asset's value are "capital expenditure" and must be depreciated.
Fire and earthquake insurance premiums
Insurance premiums on the rental property are fully deductible (apportioned if prepaid over a long term).
Loan interest (interest only)
Only the interest portion of a housing loan or apartment loan is an expense. Repayment of principal is not an expense.
Depreciation (most important)
You can deduct the building's acquisition cost each year over its useful life. Its biggest feature is that it becomes an expense even though no cash goes out.
Other expenses
Tax accountant fees, advertising costs (recruiting tenants), and travel and communication costs related to real-estate income are also deductible on an apportioned basis.
Calculating depreciation
Wood-frame: 22 years / Steel-frame (3–4 mm or less): 19 years / Steel-frame (over 4 mm): 34 years / Reinforced concrete (RC): 47 years
Used property past its statutory useful life: statutory useful life × 20% (minimum 2 years)
Used property within its statutory useful life: (statutory useful life − years elapsed) + years elapsed × 20%
Useful life (simplified method): 22 years × 20% = 4 years
Annual depreciation: ¥10 million ÷ 4 years = ¥2.5 million (no cash outlay)
Rental income ¥2.4 million − depreciation ¥2.5 million = real-estate income of −¥100,000 → can be offset against salary income
Recovering income tax on salary through loss offsetting
When real-estate income runs at a loss, you can offset it against salary income to save on income tax and residence tax[National Tax Agency No.1391].
Income after loss offsetting: ¥7 million
Tax savings (income tax rate 23% + residence tax 10%): ¥1 million × 33% = ¥330,000 in savings
・Interest on a loan taken to purchase land (only the building portion can be offset)
・Expenses for the portion used in your daily life
・Real estate not used for "business," such as a vacation home
Taxes when you sell real estate (capital gains)
Owned 5 years or less (short-term transfer)
Income tax 30% + residence tax 9% = a combined rate of 39%. A very heavy burden.
Owned more than 5 years (long-term transfer)
Income tax 15% + residence tax 5% = a combined 20% (including the special reconstruction income tax, income tax is 15.315%). Holding for more than 5 years roughly halves it.
* Short-term versus long-term is judged by the holding period "as of January 1 of the year of sale." Note that even if 5 years have actually passed since acquisition, if the holding period is 5 years or less as of January 1 of the year of sale, it counts as a short-term transfer (in practice you need to hold across parts of 6 years)[National Tax Agency No.3211].
Deducting annual depreciation lowers the building's "acquisition cost." At sale, the capital gain is the difference between the "acquisition cost (after depreciation)" and the sale price, so selling after a long period of depreciation generates a large tax burden.
Making use of the blue return
You can also elect the blue return for real-estate income (a notification of business start and an application for approval of blue return are required). If you have fewer than 5 buildings or 10 rooms, only the ¥100,000 deduction is available. You can also carry forward a real-estate loss (the part that cannot be fully offset) for 3 years to subsequent years.
Summary
FAQ
Do employees need to file a tax return for real-estate income too?
An employee whose income other than salary (such as real-estate income) exceeds ¥200,000 a year must file a tax return. You also file when you take a loss, offset it, and receive a refund.
Does creating a loss through depreciation really save tax?
Because depreciation is an expense with no cash outlay, you can offset a loss on paper against salary income to reduce income tax and residence tax. Note, however, that at sale the acquisition cost is lower, so the capital gain is larger.
Can anyone use the ¥650,000 blue-return deduction?
To claim the ¥650,000 or ¥550,000 deduction on real-estate income, you need "business scale (roughly 5 buildings or 10 rooms or more)" plus double-entry bookkeeping and electronic filing, etc. If you fall short of that scale, the deduction is ¥100,000.
How is long-term versus short-term determined on a sale?
If the holding period exceeds 5 years as of January 1 of the year of sale, it is long-term (a rate of about 20%); if 5 years or less, it is short-term (about 39%). Because the January 1 standard applies, in practice a holding across parts of 6 years is the guideline.
Reference links (sources)
This article is based on the following materials published by the National Tax Agency (neutral, primary sources). Useful lives, tax rates, and the like may be revised, so please check the latest content before filing. For details on the blue return, see also Blue return versus white return.
- National Tax Agency No.1370 When you receive real-estate income (real-estate income) (in Japanese)
- National Tax Agency No.2100 Overview of depreciation (in Japanese)
- National Tax Agency No.1391 Offsetting a real-estate loss against other income (in Japanese)
- National Tax Agency No.3202 How to calculate capital gains (separate taxation) (in Japanese)
- National Tax Agency No.3211 Calculating the tax on short-term and long-term capital gains (in Japanese)
* This article is general information, not tax or investment advice. For individual decisions, please consult a tax office or a tax accountant.