Tax Benefits Of Real Estate Investing

Real estate investing is a great venture that can earn you good returns, especially when doing it passively, and comes with tons of tax benefits.

Therefore, it’s good to identify and understand how you can take advantage of these strategies and their impact on your income taxes. For that reason, you need extensive research to discover such opportunities. But, the course is worth the effort!

Tax benefits will lighten your tax burden or eradicate certain tax obligations, so you can build substantial long-term wealth.

This article comprehensively summarizes the available tax benefits in real estate investing. Let’s dive in!

What Is The Meaning Of Tax Benefit?

Typically, ‘tax benefit’ means any tax law aiming at minimizing your tax bill after fulfilling specific eligibility requirements.

For instance, in REITs real estate investing, you can benefit from a 5% and 10% withholding tax for residents and non-resident unit-holders.

There are various tax benefits, and we look at each in the next section. Keep reading.

6 Top-Ranking Tax Benefits Of Real Estate Investing

Real estate offers tax advantages as incentives for investing in shopping centers, commercial and industrial buildings, vacant land, apartments, and rental properties.

A real estate venture can yield significant tax savings, including:

Depreciation
Deductible expenses
Capital gains
A passive income and pass-through deduction
Self-employed without the FICA tax
Incentive programs

Let’s look at each of them in detail. Read on.

1. Depreciation

Real estate depreciation is the accumulative value loss of assets years down the line due to implied wear and tear. Hence, you deduct depreciation as an expense from rental property income. As a result, you reduce your taxable income and tax liability.

You can deduct depreciation of the asset’s entire expected life. According to Internal Revenue Service(IRS), the expected property life is 39 years for commercial properties and 27.5 years for residential properties.

For example, if you want to rent a residential property worth $500,00 (building value only), the depreciation value is the building cost divided by 27.5 years ( life expectancy). You can deduct this value ($18,1812) from your annual income to get your taxable income.

However, after selling the property, you must pay the standard income tax depreciation rate known as depreciation recapture. It’s advisable to seek professional advice from your accountant on significant improvements depreciation made on your investment properties.

2. Deductible Expenses

The real estate tax deductions channel from exempting the expenses directly linked to your business’s management, operations, and maintenance from taxation. These write-offs include:

Building maintenance and repair cost
Property management fees
Property insurance
Mortgage interest
Property taxes

The deductions also extend to qualified business expenses such as:

Adverting and travel costs
Legal and accounting fees
Business equipment
Office space

When you less these expenses from your taxable income, the amount of tax you pay also lowers. Consequently, you save a lot from your tax payments.

For example, if your qualified business expenses sum up to $10,000 and your rental income is $30,000, then your taxable income is $20,000. In this case, the tax benefit is equivalent to the tax chargeable to $10,000.

However, you must keep accurate and detailed records and secure all the supporting documents like receipts. They’re necessary when proving your expenses during auditing.

3. Capital Gains

Capital gain is the increment of the asset’s value realized when the property is sold. You pay a capital gain tax on any value above the cost of buying the asset plus the improvement cost if any.

For example, if you bought a property at $ 200,000 and sold it for $300,000, your gain is $100,000 and is taxable. But, if you improve the asset at the cost of $50,000, then your taxable profit is $50,000.

Capital gain tax is simply the tax charged on an asset’s appreciation. However, it also depends on the amount of your earnings, how long you’ve had the property, and your tax filing status.

Moreover, we’ve long-term and short-term capital gains whose effect on your tax differs.

Short-Term Capital Gains

Any gain you get from selling an asset you held for a year or less is short-term. Such capital gains can affect your taxes negatively as they become part of your general income. And thus, they’re taxed according to your tax bracket.

For example, if you earn $150,000 from your regular job and a profit of $100,00 from a real estate investment, your taxable income is $250,000. The tax is larger than your usual general income tax.

Long-Term Capital Gains

Contrastingly, long-term capital gains are those you get from selling an asset you held for more than a year. Such gains minimize your taxes as they have a significantly lower rate than your general income. And if your income is too low, you may not pay any tax.

For example, if your annual income is $40,000, your long-term capital gain attracts no tax since your tax bracket is 0%.

4. A Passive Income And Pass-Through Deduction

The write-off dates back to 2017 upon introducing the Tax Cuts and Job Act of 2017. It allows you to lessen your Qualified Business Income (QBI) by up to 20% on your personal taxes. According to the real estate tax law, QBI is the rental fee you collect through partnership, sole proprietorship, pass-through entities (S Corp), or LLC.

For example, if you own a rental property that generates $60,000 annually, the pass-through deduction strategy allows you to deduct $12,000 annually on your return. You can liaise with your accountant for more information about the applicable rules and regulations.

Note that the income you obtain in this real estate investing is termed passive income by the IRS, even if bringing tenants may be a bit engaging. Consequently, depending on your property type, you may qualify for more tax advantages.

This tax incentive and other provisions in the Act will expire in 2025.

5. Self-Employed Without The FICA Tax

As a self-employed individual, you’re entitled to pay the employee and the employer FICA tax, according to the Federal Insurance Contributions Act (FICA). That includes 15.3% for Social Security and Medicare income tax.

Nonetheless, if you’re a real estate investor, your proceeds from the property aren’t categorized as earned income under the FICA Act. Consequently, you enjoy a real estate tax break by evading the FICA tax (payroll tax).

Remember that rental income is subject to taxation under the general income guideline. Hence, you need to file a Schedule E tax form to inform the IRS of your rental income and to what extent they’ll apply taxes.

Also, some rental activities may attract self-employed taxes. And, you must enquire from a professional about such.

6. Incentive Programs

The government can use incentives to encourage investors to pay taxes. In real estate investing, here are some of the significant incentive programs:

Opportunity Zones

The US Department of Treasury offers tax breaks to encourage investors to invest in disadvantaged or low-income zones and boost the economic growth of the regions. Opportunity zone incentives are under the Tax Cuts and Job Act of 2017.

In this type of real estate investing, you’re expected to put your unrealized capital gains into a Qualified Opportunity Fund. The government uses those funds to improve undeveloped areas.

As an investor, you gain from the following tax benefits:

Deferred capital gains payment until 2026, or when you sell your share in the fund
Capital gains growth by 10% by holding the fund for 5 years and 15% for 7 years
Total capital gains non-payment for investing continuously for 10 years or more

Tax-Free or Tax-Deferred Retirement Accounts

Some of these accounts, like the Roth IRAs and 401(k) plans, allow you to invest in various assets apart from bonds and stocks. The available opportunities include commercial or private real estate, REITs, and other properties.

Even so, each of the accounts has savings contribution limits and requirements. Hence, you need to seek professional advice from financial specialists to know how they can reduce your tax obligation.

1031 Exchange

This incentive rewards you for reinvesting your real estate proceeds. After selling a property, you should invest in a similar one but of equal or more value. In these transactions, you gain by not paying taxes upon selling the asset: You invest the whole amount.

However, you must pay all the pending taxes if you need to cash out the property.

Wrap Up

Are you a potential or current real estate investor? There are tons of tax benefits of real estate investing at your disposal! Whether you take a passive or active role, you can reduce your tax obligations through these incentives.

With the six tax burden relief strategies provided in this article, you can weigh each to determine which one can keep more money in your pocket and less into the tax basket.

Additionally, you must keep accurate and updated records for all expenses and improvements to maximize your tax benefits. Have also all the documents that support your records.