5 Tax Benefits for Real Estate Investors
One of the best ways to maximize your profits is to educate yourself on tax benefits, specifically ones that are available to investors.
Real estate is a lucrative business, especially if you maintain a diverse portfolio of properties. One of the best ways to maximize your profits is to educate yourself on tax benefits, specifically ones that are available to investors. Taking advantage of these unique perks will help you keep more money in your pocket when it’s time to file your taxes. From deductions to IRS-approved exchanges, here are five real estate tax benefits to take advantage of.
One of the greatest tax benefits for real estate investors is found in the form of deductions. There are many tax write-offs specifically associated with rental properties, which means there are plenty of opportunities to save.
If you’re the owner of an investment property, you can write off business-related expenses, such as:
- Mortgage interest
- Property taxes
- Advertising costs
- Maintenance costs
- Repair costs
- Home office expenses
- Work expenses, such as your internet and phone bills
- Property management fees
- Business equipment or software
- Legal and accounting fees
- Travel to and from your properties for inspections, repairs, etc.
You’ll have to pay for all these expenses anyway, so why not make them work to your advantage? The more you can write off, the lower your taxable assets will be. This is why owning real estate is a great way to earn passive income.
The IRS allows real estate investors to deduct the incremental depreciation of a rental property over its lifetime if it meets certain requirements. The following standards must be met:
- You own the property and use it for business or income.
- The property will eventually wear or lose value due to natural causes or aging.
- You believe the property will last for more than one year.
This tax benefit allows you to recover money you’ve spent to maintain an income-producing property. To be effective, most investors will use the Modified Accelerated Cost Recovery System to determine how much depreciation can be deducted each year.
3. Capital Gains
Profit earned from the sale of a property is referred to as capital gain. This is calculated by subtracting the amount you paid for the home, as well as the cost of any improvements, from the final selling price.
Based on your income and how long you’ve had the property, you will pay either short-term or long-term capital gains taxes at a designated rate.
Short-term capital gains taxes apply to properties you have owned for less than a year, which puts you in your regular tax bracket without any special treatment. For investors, long-term capital gains are much more favorable.
Simply waiting at least one year will help you keep more money from the sale. Depending on your income and tax bracket, your tax liability for long-term capital gains may be incredibly low. In some cases, investors won’t owe anything.
4. FICA, Self-Employment Taxes
When you’re investing in real estate, it’s important to structure your business in a way that will keep your tax burden low. The Federal Insurance Contributions Act (FICA) is a 15.3% tax that is typically split evenly between employers and their employees. If you’re self-employed, you’re responsible for paying the full 15.3% on your own, which is then referred to as the self-employment tax.
Because the IRS does not view real estate investments as a job or even a self-employment business, you are exempt from FICA and self-employment taxes. That said, it’s important to work with a tax professional and legally structure your investments in the right way. Certain types of structuring may trigger the FICA tax if you’re paying yourself a salary.
5. 1031 Exchange
If you feel like it’s time to sell a property, the unfortunate reality is that capital gains and depreciation can take a toll on your bottom line. A 1031 exchange can help save you money.
A 1031 exchange allows you to swap one investment property for another similar property. The IRS states the following: “Generally, if you make a like-kind exchange, you are not required to recognize a gain or loss under Internal Revenue Code Section 1031.”
Maximize Your Savings While Investing
In addition to taking advantage of these tax benefits, look for opportunities to save when you’re buying new properties. For example, a home buyer rebate can help you receive cash back after closing. This is just one way you can reduce the initial financial burden of buying a property.
Building your portfolio with diverse properties will pay off in the long run, but it can take quite a bit of time and money to get there. By taking advantage of incentives and tax benefits, you can acquire more properties. More properties will naturally help you achieve long-term financial stability with the right strategy in place.
Luke Babich is the Co-Founder of Clever Real Estate, a real estate education platform committed to helping home buyers, sellers and investors make smarter financial decisions. Luke is a licensed real estate agent in the State of Missouri and his research and insights have been featured on BiggerPockets, Inman, the LA Times, and more.
Education: B.A. with Honors, Political Science — Stanford University