Every property investor wants more ways to improve the profits on their investments. One of the most talked about ways they can do this is by accessing the tax benefits available for investment properties. But this is also one of the least understood benefits of real estate investing.
Due to their lack of insight on tax matters, thousands of property investors pay millions of dollars in tax that they did not have to. This is money that could have gone to improving the appearance and operation of their properties or their bottom line.
As a real estate investor, you need a qualified tax professional on your team. This person can help you navigate the murky waters of real estate taxation. He or she will ensure that you take full advantage of available tax incentives, without getting into trouble with the IRS.
However, you should also understand how real estate taxes work. This knowledge will make your tax advisor’s work easier and also help you make better investment decisions. Click here to learn more about taxes and other property investment terms.
Below are the critical things you should know about real estate taxes.
Here are the tax benefits of real estate investing
1. Tax deductions
The government allows property investors to make legitimate tax deductions from their rental income on important expenses on their property. For example, money spent on renovations or professional fees can be deducted before calculating taxes. These deductions have always existed for property investors.
But, the Tax Cuts and Jobs Act of 2017 (TCJA) extended the range of benefits investment property owners can enjoy under this law. Section 199A of the Internal Revenue Code actually allows 20% of your rental earnings to be deducted right off the bat, regardless of how much you earn.
2. Tax benefits of investing in Qualified Opportunity Zones
Certain locations are designated by the government as Qualified Opportunity Zones. These are often low-income neighborhoods that property investors would ordinarily not want to buy assets in. Investors’ reluctance to put money into these communities locks them in a vicious cycle of poverty.
The government offers rewards to investors who buck the system by buying properties in these locations. When you invest in a property within a Qualified Opportunity Zone, your tax liability drops by 15%. However, bear in mind that there are rules to follow.
3. Depreciation deduction
Depreciation is based on the idea that an asset gradually loses value over time known as its useful lifetime. As time goes on the asset becomes less valuable until its value falls to zero.
This amount is calculated and deducted over the course of several years.
In addition to calculating and deducting the asset’s depreciation before paying taxes, you are allowed to make deductions on expenses that slow depreciation. When you do repairs or improvements on the home, you are allowed to make deductions on those expenses.
4. Tax relief when you invest with a Self-Directed IRA
A Self-Directed IRA (SDIRA) is different from the regular Individual Retirement Account (IRA) in that you can hold investments normally prohibited from standard IRAs. Using this avenue gives you the best of two worlds; the tax benefits of real estate investing and the tax relief of an IRA.
Just as with your 401(k), taxes are deferred until you withdraw your funds. This strategy works even better with a Roth SDIRA. But bear in mind that this method is not for inexperienced investors; if you want to take this route, please use the services of a professional manager.
5. Lowering your capital gains tax
Capital gains tax is paid when you sell your investment. The timing of that sale can influence how much you pay in capital gains tax. If your property is sold within a year or less of your acquiring it, you will be taxed at the rate of 10% – 37%. The actual rate will depend on your income bracket.
However, if you sell the same property just one year and a day after you bought it, your capital gains tax rate falls to 0% – 20%, also depending on your income bracket. Just by waiting a few days or weeks before selling your assets, you can shave a potential 17% off your capital gains tax rate.
What to do to access tax these benefits
There are three key things you need to maximize the tax benefits on any real estate investment:
- Complete and up-to-date records: Without good record keeping, you cannot keep track of income and expenses. Every receipt and invoice matters when calculating taxes and deductions. Proper record keeping will save you time and money.
- Know what expenses are tax-deductible: Not every operational expense on a property qualifies for tax deductions. Knowing which expenses are tax-deductible will help you channel your money into costs that can be partially recouped through tax deductions.
- Track and measure: Your investment direction and management strategy should be guided by a need to maximize value via tax benefits. The value of every decision should be measured in terms of its impact on how much you will pay in taxes.
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