Real Estate and Taxes

property investment

Taxes are a fact of life, yet, one of the areas where one can get decent tax returns, tax advantages, predictable cash flow, and make a “tidy sum” in the real estate market.

Real estate investors make money through rental income, appreciation, and profits generated by business activities that depend on the property. And as real estate value tends to increase over time, with a good investment, you can turn a profit when it is time to sell. Rents also rise over time, which in turn leads to higher cash flow.

Tax Breaks and Deductions

Real estate investors can take advantage of several tax breaks and deductions that can save money when the time comes to pay taxes. In general, you can deduct the reasonable costs of owning, operating, and managing a property.

Depreciation deduction from income. This tax deduction is based on the perceived decrease in the value of the real estate.

And since the cost of buying and improving an investment property can be depreciated over its useful life (27.5 years for residential properties; 39 years for commercial), you benefit from decades of deductions that help lower your taxed income.

Capital Gains. These are the profits that homeowners make when they sell their real estate property. These include rental, residential, commercial, or industrial property.  They are generally taxed in one of two ways: short term capital gains, long term capital gains.

Short-Term applies to gains on investment properties that were held for one year or less. While there is no special tax treatment for short term capital gains, investors will need to pay taxes at their regular IRS-defined tax bracket.

Long-Term capital gains are made on properties held for over one year, which are generally linked with rental properties. Capital long-term gains are much more favorable for investors as it’s a lower tax rate than short-term gains.

With Long-Term capital gains, you will be taxed far less, and you can utilize previous deductions to lower the taxable amount.

Investors can also use the capital gains exclusion, which is probably the biggest of all the tax benefits. This can be used more than once to allow homeowners to be exempt from paying taxes on profits up to $500,000 from selling their homes. In a worst-case scenario, if capital losses exceed capital gains, investors will be allowed to offset upwards of $3,000 of other income.

Mortgage interest tax deductions from income. A mortgage interest tax deduction is the interest you took for your mortgage loan, and this real estate tax deduction is usually your biggest one.

Other considerations include:

  • Deferral of capital gains via 1031 exchange
  • Cost of repairs, maintenance, and upkeep
  • Cost of services (rental property management & legal consultation or services)
  • Utilities

The Real Estate Tax Benefits of an LLC.

Tax advantages can also be found in how you chose to own the income property. It may be beneficial to own the property through an LLC instead of your own name.

Owning an investment property through a limited liability company serves to insulate one from liabilities, as well as insure against double taxation. Double taxation is avoided on funds received through the collection of rent and if the property is sold later on.

An SDIRA can also be used to purchase a property. There are great additional tax savings to be had. Although there are additional steps required, it presents a genuine advantage.

If you are going to be using either of these additional real estate tax advantage strategies in purchasing an income property, you are advised to do so from the start. Trying to move a rental income property from personal ownership to an LLC or an SDIRA after closing could cause additional headaches and potentially a taxable event.

If you have any questions on Taxes and your Real Estate, don’t hestitate to reach out!

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