Best Tax Strategies for Investing in Real Estate

Finding and using the right tax strategies for a real estate investor is the hardest part of investing in real estate, however, it’s also the most rewarding.

The benefits of these  real estate investing tax strategies aren’t immediately apparent, and they often necessitate a great deal of digging. However, the payoff can be substantial. There are proven strategies to help you lower your tax returns while investing in real estate.

You can build long-term wealth by taking advantage of these tax strategies for real estate investors, to reduce or eliminate certain tax obligations. However, before proceeding with the tax strategies, we will first of all determine if investing in real estate is tax deductible.

Is Investing in Real Estate Tax Deductible?

Yes, one significant benefit of real estate investment is the ability to earn tax deductions. These deductions for rental properties can include (but are not limited to):

• Interest payments on a mortgage
• Taxation on real estate
• Ongoing property maintenance
• Property insurance
• Independent contractors

Real estate investors can maximize tax advantages by investing in real estate through limited partnerships and limited liability companies. These structures ensure additional business-related deductions like:

• Professional fees
• Expenses for office space, travel, and mileage
• Real estate software applications

Best Tax Strategies for Real Estate Investors

Several provisions in the tax code relate to real estate investing tax strategies to reduce tax liabilities or to generate refunds. It’s possible that some of these concepts have been around for a while, while others are more recent additions. These are the five tax strategies:

1. Depreciation

The question many real estate investors ask is “how does depreciation affect taxes?” Before delving into the answer, it’s important to understand depreciation first. Depreciation is a form of compensation for the “wear and tear” of a property over time, and it can be taken as a tax deduction.

Annual tax deductions allow investors to recoup maintenance expenditures on their investment properties through the practice of depreciation. A net loss on a real estate investment is always included for tax purposes, regardless of whether or not profits are earned.

On market value basis, recovery period, and depreciation method the allowed deduction amount is determined. Residential and commercial real estate can depreciate for 27.5 years and 39 years, respectively, under the modified accelerated cost recovery system, which is the most common type of depreciation.

2. Self-Employment/FICA Tax

The 15.3 percent income tax on Social Security and Medicare is divided evenly between your employer and you. However, if you’re self-employed, the responsibility for the entire 15.3 percent lies on you.

Although rental income is subject to standard income taxation, FICA taxes are not deducted. You can avoid paying social security and Medicare taxes on rental property income even if you’re self-employed, thanks to these real estate investing tax strategies.

3. Opportunity Zone Funds

Investing in the country’s most rural and economically depressed areas is encouraged by the Tax Cuts and Jobs Act of 2017. You can defer capital gains tax on your initial investment by putting the proceeds from the sale of other investment properties in these designated Opportunity Zones.

4. 1031 Exchange

A 1031 Exchange is a real estate investment transaction in which one property is exchanged for another of equal or greater value. An asset swap that qualifies for a tax-free or low-taxed exchange is different from most other asset swaps.

To avoid paying capital gains taxes, keep the asset for at least a year before selling it. That is to say, you owe capital gains taxes only if you sell a property for a gain rather than a loss.

To be eligible for a 1031 exchange, the properties must be exchanged for a definite asset. A significant difference in the new property’s worth compared to the value of the property that was traded must be evident. Besides that, the property must also be used for business purposes.

5. Passive Income and Pass-Through Deduction

Rent-related business activities, where investors aren’t active are examples of passive revenue in real estate investing. This kind of income isn’t eligible for tax breaks.

Rental property owners can now take advantage of new pass-through tax deductions under the Tax Cuts and Jobs Act passed in 2017.  Investors may be entitled to deduct up to 20 percent of their net rental revenue, or five percent of the property’s initial purchase price, plus 25 percent of employees’ payroll costs for the year.

Deductions for rental expenses aren’t included in this new tax break, implemented in 2018. This tax break is set to expire at the end of 2025.

The Tax Advantages You Receive From Investing in Real Estate Could Influence Your Future Choices

When it comes to making smart investment decisions, knowing the techniques to lower real estate taxes is essential. Personal or business-related strategies can be influenced by a thorough understanding of where your deductions are coming from, how they’ll be applied, and the expected amounts.

There are several reasons you might want to keep as much information as possible on your property. These renovations, additions, and costs should be documented. Ensure to keep track of the property’s estimated market value, too.

Hiring an experienced certified public accountant (CPA) is recommended if you need an expert to handle this part of the investment process. However, don’t forget to familiarize yourself with these strategies and keep detailed records of all of your real estate investment expenses. These will be helpful in these types of discussions, saving you CPA fees and simplifying your tax preparation.

Conclusion

Suppose you want to benefit from tax deductions, you must first understand the rules. Nowhere is this more evident than when learning how to lower your real estate taxes.

It’s practicable to keep your properties till death and have your children inherit them with as little tax as possible. These real estate tax strategies will help you leave a winning legacy behind. Consider going through the 1031 exchange companies for sale here to find what fits. Congratulations on your investment!