8 Great Tax Benefits of Real Estate Investing
We will be looking at the tax benefits of real estate investing next. T.S. Elliot said April is the cruelest month. Perhaps because it’s tax season? I don’t mean to rub it in, but in my house, we look forward to April. You’re about to see why, but first…
Before we dive in, I just want to clear the air and remind you that I’m not a tax professional. These 8 reasons are derived from my personal experiences as a real estate investor, investor in commercial real estate, as well as investments in real estate syndication. I have a lot of experience, but I’m not a CPA.
Phew, now that that’s settled, let’s get on with the show!
1. IRS Goes Easy on Real Estate Investors
Tax Benefits: IRS Goes Easy on Real Estate Investors. - Photo by Pixaby
You can earn a gangbuster return on your real estate investment and still have plenty of tax write-offs to lower the amount of taxes you owe. It’s true, the tax code favors real estate investors. In fact, it’s likely more folks have gone from rags to riches through real estate investing than other avenues such as stocks and entrepreneurship.
Because the IRS sees value in real estate investing because it’s centered on putting a roof over peoples’ heads. Afterall, citizens and residents have to live somewhere. As such the tax code encourages homeowners to maintain their property and make improvements and upgrades. In so doing, these homeowners are compensated via tax write-offs.
2. Passive Investors can Enjoy the Same Tax Benefits as Active Investors
Passive Investors can Enjoy the Same Tax Benefits as Active Investors. - Photo by Pixabay
While you may be a regular ‘ole passive investor (nothing regular about it, actually), you can still benefit from the same tax advantages that an active investor enjoys. For example, passive real estate investing, (such as investment in a real estate syndication or apartment syndication), has awesome benefits. Even though you aren’t out there scraping your knees replacing tile in the bathroom or replacing the roof, you are still getting the full tax benefits. Reason being, you invest in an entity that owns the property, therefore any tax benefits that the entity enjoys is “passed through” to you, the investor.
I recommend that you check in with a Sponsor or a General Partner in apartment syndication about the Schedule K-1 form and be sure to speak with your CPA about it.
You’d be surprised at just how many tax benefits there are as a passive investor in real estate syndication. You can write off expenses related to the property that go beyond repairs and upgrades. These included: utilities, payroll, interest… and <drumroll> depreciation.
My recommendation? Check with your Sponsor or General Partner in apartment syndication about the K-1 form, and as always, be sure to speak with your CPA.
3. Depreciation isn’t as Gloomy as it Sounds
Everything falls apart. Fortunately, that’s a tax benefit!
Who knew entropy has some advantages?
The IRS knows that as properties depreciate over time, they lose their useable value over their lifespan. Depreciation allows us to deduct the costs of improving a property. The depreciation distributes the deduction across the useful lifespan.
As far residential real estate goes, the IRS allows you to write off the value of the property (not the land) over 27.5 years. Why can’t you claim depreciation on the land? Because it’s still worth the same (perhaps more than when you bought the property). However, the structure does certainly depreciate if no improvements are made.
4. Capital gains = uh oh, but not Really…
When you sell your property, the IRS gets back some money through capital gains tax, and depending on the sale price, depreciation recapture.
“Recapture”? Yes. The IRS remembers everything.
However, if you invest in a real estate syndication that holds the property for 5 years (as an example), you needn’t worry about capital gains taxes and depreciation recapture until the asset is sold in the 5th year. As well, the capital gains tax and depreciation recapture depends on the hold time and your tax bracket.
5. 1031 Exchanges are Super Cool
It’s nice to know you can roll your return on investment into the next property rather than give up so much of your gains. - Photo by Pixabay
Remember how I said that when you sell a real estate asset, you have to pay capital gains taxes? This is still true, however there is a workaround called a “1031 exchange.”
With a 1031 exchange, you can sell one investment property, and within a set amount of time, swap that investment property for another. It’s also called a “like-kind” exchange. In effect, this means whatever profits you earned are funneled into the next investment rather than receiving the profits directly. Consequently, you wouldn’t owe any capital gains taxes.
It’s nice to know you can roll your return on investment into the next property rather than give up so much of your gains, via appreciation and equity, to the tax man.
Talk about a value add!
6. Capital Gains Home Exclusion
Here’s another cool thing about capital gains – if you’ve owned and used a property as your primary residence (your “main home”) for at least two out of the last five years before you sell it, you don’t have to pay capital gains tax up to $250,000 of that gain from your income. Or, if filed jointly with your spouse, up to $500,000.
In other words, let’s say you purchased a home with your spouse for $250,000. The first two years you lived in this house, so it was your “main home” for those two years. Then you decided to rent it out for three years and lived somewhere else. Now, year five you decide to sell. Guess what the sale price is? $750,000. Lucky you, right? Well you’re especially lucky because you qualify under the capital gains home exclusion to receive that profit (which is $500,000) completely tax-free.
If you’re a high-earner and in a higher tax bracket, this means big savings!
7. Watch this Neat Trick – Zero Self-Employment or FICA Taxes on Paid Rental Income
“The hardest thing to understand in the world is the income tax.” - Photo by Pixabay
The nice thing about rental income from your investment properties? It’s not applicable to social security and Medicare taxes.
In other words, if you are self-employed, you know that you must pay 15.3% toward the FICA tax on your income – however, this tax does not apply to rental income.
For self-employed folks, not paying this FICA tax on your rental property might vaguely feel like you’re getting away with something.
8. Rich People Invest in Real Estate for the Tax Advantages
The well-to-do often invest in real estate so they can enjoy all these tax advantages. With the various write-offs and depreciation, they’re able to reduce their taxable income.
Not too Shabby, eh?
Thanks to these tax benefits, real estate and real estate syndication offers lots of attractive tax advantages that can further your aspirations to be cash flow positive. From when you first buy your home to handing the keys over to the buyer when you sell, there are ways to actually enjoy doing your taxes!
The real estate investing tax benefits are nearly endless. - Photo by Canva
Delphine Nguyen, Investor
Delphine Nguyen is a real estate investor and a licensed real estate broker in Illinois. She learned to be successful from a variety teachers, including her own mistakes. Real estate investing is her passion. Helping others to achieve their goals is another passion that she has. She does what she knows best, therefore, her focus is solely on multifamily and co-living investment types.
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