Investing in real estate is one of the best things you can do to ensure consistent returns and keep your money secure. This is because all taxes that are commonplace and essential to the management, preservation, and maintenance of the property are deductible. Interest on mortgages, taxes on buildings, marketing, upkeep, utilities, and insurance are typical components of property management. However, as an investor, you can deduct the cost of maintaining a property since it preserves its worth. This makes investing in real estate a smart bet. That being said, today, we will cover the biggest tax benefits of real estate investing.
1. Investment Income and Pass-Through Deductions
Earnings from real estate investments in which the investor does not take an active role are called passive income. That said, rental income from investment properties is the most prevalent source of passive income. Before 2018, passive income and losses were the only two things landlords could use to balance each other. However, by the end of that year, the Tax Cuts and Jobs Act provided some welcome relief for those who rely on passive income. It allows companies to pass on up to 20% of their taxable revenue if they have qualifying business income (QBI), which may include rental income.
That being said, pass-through deductions make all of this possible. This results in a significant decrease of 20% in the effective income tax rate. However, the future of this Act, which provides this benefit until 2025, is uncertain. Please remember that if your firm made a profit during the tax year in question, only then will you be eligible to claim this pass-through deduction. Pass-through deductions are not available for all forms of income. You should review the laws of the Internal Revenue Service (IRS) or partner up with experts when choosing a tax relief company, and they can help you with passive income and pass-through deductions.
2. Capital Gains
Owners of any kind of real estate (investment, primary residence, commercial, or industrial) are entitled to capital gains upon the sale of their property. They are typically taxed in one of two ways. First, there are the advantages of selling an asset quickly, and second, there are the gains from holding onto it for a more extended period.
- Short-Term: Capital gains from investment properties you hold for less than a year fall under this category. Investors will be subject to taxation based on their typical income tax rate, as the Internal Revenue Service (IRS) provides no preferential treatment for short-term capital gains.
- Long-Term: Rental properties you would hold for longer than one year are the most common type of long-term capital gains. In terms of taxes, long-term capital gains are far more beneficial to investors than short-term ones.
Capital gains exclusion is one of the most important tax breaks for investment properties, and investors need to be aware of it. To avoid paying taxes on capital gains of up to $500,000 on the sale of a primary residence, homeowners may exercise this exemption several times. Investors may deduct up to $3000 in expenses from their taxable income if their capital losses exceed their capital profits. Investors come out ahead either way.
3. Paying Taxes on Capital Gains Instead of Wages
As we’ve said, profits from the sale of an asset are subject to taxation, depending on whether they are considered short-term or long-term capital gains. Because of its classification, this rate is often lower than income tax and may give some tax relief. To avoid paying capital gains tax, you may consider real estate investing via various tax-deferred or tax-free strategies. Real estate owned for less than a year often results in a short-term capital gains tax rate between 10% and 37%. Gains on investments held for more than a year are subject to a lower tax rate, anywhere from 0% to 20%. You may find detailed descriptions of these approaches below.
Depreciation is a major tax advantage for rental properties. One way to do this is to claim a tax deduction each year equal to the cost of the asset that generates the income. The Internal Revenue Service defines depreciation as a deduction for wear and tear. An investor’s annual depreciation deduction is based on three elements:
- Value of their stake in the property.
- Property recovery time.
- The depreciation approach they used.
The Modified Accelerated Cost Recovery System (MACRS) is the most common depreciation approach investors use these days. In fact, with this method, investors can write off depreciation on residential real estate for 27.5 years, while businesses can take 39. Even if an investment property has positive cash flow, the depreciation it incurs will still be a loss.
5. 1031 Exchanges
Real estate investors may delay capital gains by selling one investment property and buying another of the same sort. This is possible because of the 1031 exchange. Despite the fact that a 1031 exchange may save you thousands of dollars in taxes, the operation is complex and has many requirements. That’s why experts at consumeropinion.org recommend that you consult different experts to make sure you get the job done right. In order to qualify for a 1031 exchange, a buyer or seller must meet the following requirements:
- All business activity must take place on the property being traded
- The two homes should be exchanged for a Real Estate Investment Trust (REIT) or another investment vehicle
- Both the value of the resigned property and the value of the replacement property must be equal or less
Some additional tax breaks exist, of course. These are just some of the biggest tax benefits of real estate investing. There are many more, but we covered only the most crucial ones you should know. In conclusion, it is clear that understanding your tax advantages may help you reduce your overall tax liability. Taxes will always exist, but there are steps you can take to lessen their impact. Combining them might increase your advantages even more. Therefore, if you haven’t considered some of these benefits yet, it’s time to do so.