Experts argue that you should not invest in real estate just for the tax benefits … but it is certainly tempting. Though the list of ways to maximize your investment is long, it is complicated and confusing. If you are just starting out, get the advice of a good real estate professional and a tax expert or CPA. Here is a simple breakdown of how real estate investing allows you to keep more of your money during tax time, according to Joseph Pingaro.
Capital Gains Tax is Less Than Income Tax
Investors who make their money from buying and selling properties pay a capital gains tax instead of income tax. Short-term capital gains tax is charged at the same rate as income tax, which can be as high as 37%.
If you own your property for a year before you sell it, then you pay the long-term capital gains tax which is at a much lower rate. The long-term capital gains tax is capped at 20% for top-earners. Depending on your tax bracket, you could pay as little as 0% on your profits.
The Capital Gains Home Exclusion Tax Benefit allows you to keep even more of your money. If the home you sell has been your primary or secondary residence for two out of the last five years and you make less than $100,000 a year, you qualify for the exclusion. This exemption is equal to $250,000 if you are single and $500,000 if you are married. You can make a profit up to the exemption amount before you have to pay any capital gains tax.
When you are just starting out, it is smart to take advantage of the exemption. One strategy to meet the requirements is to live in your house while you rehabilitate it. This not only saves money on taxes but also on housing expenses.
Defer Your Capital Gains Tax With a 1031 Exchange
When you sell your investment property and intend to purchase another one right away, you can defer your capital gains to the next property. After your original sale, you must find a property that is comparable or better within 45 days. You will need to finalize the purchase within 180 days. This can be useful when you want to diversify or change your property investments.
Take Advantage of Depreciation
While this may be a confusing concept, the building on your land depreciates—much like a car. You will eventually need a new roof, new plumbing, new carpet, and the list goes on. This fact can be one of your biggest assets. The IRS allows the depreciation of your building as a write-off, with the total loss divided over 27.5 years.
So, let’s say you invest $120,000 into a property and the house itself is worth $90,000; every year, you would be able to deduct about $3,275.
The catch to this write-off is that you can only use it to offset passive income like rent. So you can’t use it to reduce income tax from your job or property sales, but there is also a catch to the catch; you can use depreciation to write off active income if you are a real estate professional.
Avoid Paying Into Social Security and Medicare
Unless you own your real estate through a holding company and pay yourself a salary, your income from this type of investment is not subject to FICA tax. This means that you will not pay into Social Security or Medicare.
These are standard deductions that come out of your paycheck when you have a traditional job and can equal between approximately 8% and 14% depending on your exact employment status, but real estate investors keep more money for immediate use because they are not required to pay into these benefits with investment income.
Deduct Property and Occupancy Taxes
Almost all counties and municipalities charge property taxes. In areas where a large number of rentals are short-term—like parts of Florida and Arizona—income from rent is taxed. The good news is that both of these taxes are completely deductible from your income when you file your federal taxes. The higher your tax bracket, the more you save.
Deduct Mortgage Interest Payments
You can only take advantage of this deduction if you took out a loan to purchase, build, or make improvements on a residential property. The property must either be your primary or secondary residence, or a rental.
If you meet the qualifications, the amount of your monthly mortgage payment allotted to interest will not count as income when you file your taxes. This can lead to significant savings and even help to knock your tax bracket down a notch.
Don’t Forget About General Operating Expenses
Qualifying circumstances are specific, but all the expenses that go into running a business are deductible. Traveling to and from your property, printer ink to print invoices, your website for advertising, hiring contractors and staff, even your office space and insurance premiums can all potentially be deducted from your gross income.
Get Help From an Expert
Real estate investment can be very lucrative, and the plethora of tax breaks will help you maximize your profits. To cover all your bases and protect your investment, make sure you get good
advicefrom experienced professionals.
