Investing in real estate is a straightforward venture...in theory. Buy a property, rent out the property, make money off of the rent. Simple, right? Unfortunately, theory isn’t reality. We have to deal with things like market climates, taxes, insurance, property management, tenant screenings, turnover, and all sorts of unforeseen complications.
One of the most daunting things for anyone of any age, real estate investor or not? Taxes.
For us, there are some unique tax advantages that we can use to leverage real value. We aren’t talking about creative tweaking that bends the rules to create write-offs. We’re talking basic principles in real estate investment that can minimize how much you pay in taxes each year, thus maximizing your passive income.
Some of these are relevant for your annual taxes, while other will be relevant year-round and for your investment strategies and decisions!
First, the Tax Tips for Real Estate Investors:
1. Add a Trusted CPA to Your Team
If you haven’t found a trusted financial advisor, start tracking one down right now. An excellent CPA is more than worth their cost to you: they can ensure you get the absolute most of out of your tax advantages and avoid pitfalls that can lead to overpaying, audits, or owing Uncle Sam.
2. Keep Track of EVERYTHING
When we say everything, we mean everything. This is where expense tracking apps really come in handy.
Here’s the thing: you probably won’t need to track everything. You probably won’t need all of those receipts. If you’ve been working with real estate investment deductions for a few years, you probably already know how it goes.
That said, the more accurate you can be and the more concrete proof you have of your business expenses, the better! A lot of things can be deducted, including things like repairs and parts that make a building habitable (like an HVAC). Keep all of those bills and receipts for anything and everything you paid for for your property or real estate business.
If you aren’t sure if it’s deductible, just keep a record and ask your CPA about it.
Things that are typically deductible:
- HVAC equipment
- hot water heaters
- plumbing and lighting fixtures
- real estate taxes
- insurance and utility charges
- commissions you paid to management companies or accountants
- home office (be careful with this one!)
- business travel expenses
- business seminars
- property repairs
3. Brush Up on What Qualifies as What
Terms and definitions are a big deal in the tax world, as you likely already know. Something that you think would be a repair, such as a new roof, might actually be categorized as a capital expense, for example. Or you may not be able to claim a depreciation for a few years. The more clear you are on categories and rules that govern the tax advantages you want to take, the easier it will be to take them and the less frustrating the whole process will be in general.
Then, The Tax Advantages in Real Estate Investment:
4. Long-Term Capital Gains
Wealthy people tend to be wealthy because they pay less, percentage-wise, in their taxes compared to other people: often because their money is in investments, not in income. That means that they aren’t dealing with income taxes in the same way most people are, if at all. Within that, there’s also what happens when you sell an investment.
When you sell a property, you’re dealing in capital gains: these are either short-term or long-term. Fix-and-flippers will likely have to deal with the short term, but buy-and-hold investors who rent out a property for years before deciding to sell will be subject to long-term capital gains.
That means instead of being taxed the normal rate (which starts at 10% and can go up to nearly 40% for regular income taxes), you’ll be paying anywhere from 0% to 25%, depending on tax bracket and marital status. That saves you a lot of money in taxes!
Most of us know this already, but it never hurts to go back over it. As long as you own a property, that property depreciates, according to the IRS. That sounds terrible, of course, but it just means that the IRS, over time, allows you to write off the cost of your investment property as a business expense. It’s like any other business deductible, just spread out over its lifespan: which, according to the IRS, is 27.5 years.
This doesn’t include the land on your investment property: just the building itself. Still, that’s likely a significant deduction for you each year.Now, there are plenty of other tax advantages to be found in real estate investment. There’s the 1031 exchange, the lack of a self-employment tax, tax-free refinancing, cost segregation, and other tricks of the trade. But these are basic principles that will help put any investor on more solid financial footing when Uncle Sam comes calling.