Marginal vs Effective Tax Rates
Why the Difference Matters for Real Estate Investors?
If you’ve ever heard someone say, “I don’t want to make more money because I’ll just pay more in taxes,” then they’re probably confusing two very different ideas:
Marginal Tax Rate vs Effective Tax Rate
I talk to so many folks who mess this up when it comes to personal finance and tax planning. And for real estate investors, it can lead to some short-sighted decisions that leave serious money on the table.
My goal for this post is to help clear it up and show how strategies like cost segregation can help lower your effective tax rate, even if your income continues to grow.
My goal for this post is to help clear it up and show how strategies like cost segregation can help lower your effective tax rate, even if your income continues to grow.
What Is a Marginal Tax Rate?
Your marginal tax rate kicks in once your income crosses into a new tax bracket, not the rate you pay across the board.
The U.S. uses a progressive tax system, meaning your income is taxed in layers. Here’s what that looks like for a single filer in 2024:
The U.S. uses a progressive tax system, meaning your income is taxed in layers. Here’s what that looks like for a single filer in 2024:
- 10% on your first $11,600
- 12% on income between $11,601 and $47,150
- 22% on income between $47,151 and $100,525
- And so on...
If you earn $100,000, you don’t pay 22% on the entire amount. Only the income above each threshold gets taxed at the higher rate.
Your marginal rate is the highest rate you pay but not the rate you pay on everything.
Your marginal rate is the highest rate you pay but not the rate you pay on everything.
What Is an Effective Tax Rate?
Your effective tax rate is the average rate you pay across all of your income.
Here’s a simple example:
Let’s say you owe $14,000 in federal income taxes on $100,000 of taxable income. That’s a 14% effective tax rate, even though your marginal rate is 22%.
This is why the “they’ll tax it all if I make more” mindset doesn’t hold up. Earning more might push part of your income into a higher tax bracket, but it won’t raise the rate on everything.
Here’s a simple example:
Let’s say you owe $14,000 in federal income taxes on $100,000 of taxable income. That’s a 14% effective tax rate, even though your marginal rate is 22%.
This is why the “they’ll tax it all if I make more” mindset doesn’t hold up. Earning more might push part of your income into a higher tax bracket, but it won’t raise the rate on everything.
That lease-type toggle lets you see just how much the structure of your rental business affects your tax strategy.
Why This Matters for Real Estate Investors
Understanding the difference between marginal and effective rates isn’t just academic, it can shape the way you approach growth, investing, and tax planning.
If you think your entire income will be taxed at your marginal rate, it’s easy to get discouraged about growing your business or buying another property.
But when you understand how the effective tax rate works and how to reduce your taxable income you start to see opportunities instead of roadblocks.
That’s where strategies like cost segregation come in.
If you think your entire income will be taxed at your marginal rate, it’s easy to get discouraged about growing your business or buying another property.
But when you understand how the effective tax rate works and how to reduce your taxable income you start to see opportunities instead of roadblocks.
That’s where strategies like cost segregation come in.
How Cost Segregation Lowers Your Effective Tax Rate
If you own real estate, you’re probably already taking standard depreciation over 27.5 or 39 years. But with a cost segregation study, you can front-load much of that depreciation and reduce your taxable income in the early years of ownership.
Here’s how it works:
Here’s how it works:
- A $1M property might have an $800K depreciable basis (after removing land value).
- Without a study, you’d take about $29K/year in straight-line depreciation.
- With a study, you might accelerate $200K–$300K of that into year one.
If you’re in a 37% federal tax bracket, that could save you $70K–$110K in actual taxes, bringing down your effective tax rate significantly.
And importantly, you’re not doing anything aggressive or risky. You’re just using the tax code the way it was written to reward investment in long-lived assets like real estate.
And importantly, you’re not doing anything aggressive or risky. You’re just using the tax code the way it was written to reward investment in long-lived assets like real estate.
Growth vs. Shrinking: What’s the Better Tax Strategy?
There’s a trap some investors fall into: thinking the way to reduce taxes is to earn less.
But the smarter (and more scalable) move is to earn more while optimizing your taxable income through strategies like:
But the smarter (and more scalable) move is to earn more while optimizing your taxable income through strategies like:
- Cost segregation
- Short-term rental tax planning
- Entity structuring
- Passive loss rules
You don’t have to slow down your business or portfolio growth just because taxes exist. In fact, the larger your income, the more valuable these strategies become.
Want to Estimate Your Own Tax Savings?
If you’re curious how cost segregation might impact your tax situation, we built a simple tool to help.
Try the Maven Cost Seg Calculator
You’ll get a quick, personalized estimate based on your property type, tax rate, and placed-in-service date with no strings attached.
Try the Maven Cost Seg Calculator
You’ll get a quick, personalized estimate based on your property type, tax rate, and placed-in-service date with no strings attached.
Final Thoughts
Your marginal tax rate doesn’t tell the full story.
Your effective tax rate is what you actually pay.
And with the right strategy, that number can drop even as your income grows.
If you’re building a real estate portfolio or scaling your business, understanding this distinction (and using it to your advantage) is a key part of tax-smart growth.
Want a free quote? Get a free proposal on your property.
About the Author
Sean Graham, CPA specializes in cost segregation, tax depreciation, and real estate tax savings. As the Chief Technical CPA at Maven Cost Segregation: Tax Advisors, he has overseen 1000+ cost segregation studies, helping investors maximize deductions.