There are two types of income related to real estate investments. The first is passive income -- the income generated from rents -- and the second is related to capital gains -- the income derived from the property’s increased value minus the purchase price. With regard to passive income, the IRS sets a limitation on the amount of losses you can take. Essentially, you can’t take losses that exceed your passive income. For example, you earn $100,000 in rental income and you have a net loss (from adding in depreciation) of $150,000. You’re limited to the $100,000 loss in a tax year. You can carry the $50,000 loss forward to another tax year. Lastly, passive income is taxed at ordinary tax rates. Next, let’s review capital gains and your tax liability. The income you receive when selling a long-term asset at a gain is taxed. The federal tax rates tend to be more favorable (15-20%). Currently, California doesn’t have a separate capital gain tax. You'll be taxed at your regular state tax rate. Ultimately your capital gains tax liability is calculated on the dollar amount the property sold for minus your capital basis (original purchase price plus capital improvements).