Tax planning is one aspect of investing in real estate that every investor needs to understand. When investors strategically manage their tax obligations, they stand the chance of reducing liabilities and maximizing profits while remaining compliant with tax regulations and laws. When you as an investor understand the different strategies that can be applied in tax planning in addition to the various deductions and benefits to be had, you can significantly increase your bottom line.
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In this article, we will provide a basic guide for investors in the real estate industry so, stay with us…
Understanding Real Estate Tax Benefits
Investing in real estate comes with some tax advantages that enables investors to reduce their taxable income. Some of these advantages include the following: –
- Depreciation Deduction – The IRS makes provision for people who invest in real estate to depreciate the worth of their properties over a specified period. Depreciation period for residential buildings is usually 27.5 years while for commercial is 39 years. This is categorized as non-cash expense which reduces taxable income and increases cash flow.
- Mortgage Interest Deduction – This is another means of reducing overall income that can be taxed because whatever interest you pay on loans used for real estate investment is tax-deductible.
- Property Tax Deduction – You can deduct the taxes you paid on your properties which in turn lowers the tax burden.
- Repairs and Maintenance Deductions -These are deductions of money spent on routine maintenance and repairs which help to offset rental income.
- Pass- Through Deduction– If you operate as a pass-through entity, you may qualify for 20% deduction on your net rental income.
Key Tax Strategies for Real Estate Investors
The following are some of the key strategies that you can employ as a real estate investor: –
- Leverage Cost Segregation– This is a strategy that drives depreciation by pinpointing specific elements of a property/building that can be depreciated faster like fixtures and appliances. This enables the property owner to access larger deductions sooner, thereby improving cash flow.
- Utilize 1031 Exchanges – A 1031 exchange is also referred to as a like-kind exchange and it allows an investor to defer their capital gain taxes by ploughing back the money made from selling one property into another property with the same features. With this strategy, an investor can boost their portfolio with deferred tax liabilities. You can visit this site https://accountinginsights.org/for more information.
- Leverage Your Professional Status – You can offset your property investment losses against other incomes. However, this is applicable to only those who are real estate professionals who meet the criteria set by IRS which includes but not limited to spending 750 hours and above on real estate activities every year.
- Establish the Right Business Structure– Taxation is impacted by the legal entity you establish your structure as. If you are more interested in tax benefits and liability protection, it is recommended you use LLC while those interested in self-employment taxes should opt for S-Corps.
- Utilize Self-Directed IRAs– When you invest in properties through a self-directed IRA, you defer rental income taxes and capital gains which enables you to have tax-free/deferred growth.
- Write Off Travel and Home Office Expenses– If you travel to go manage your properties, you can deduct travel expenses such as airfare, meals and lodging. In the same vein, if you manage your rental properties from home, you stand a chance of getting a home office deduction.
Minimizing Capital Gains Taxes
Property sales attract capital taxes and this can impact your savings and profit. The following therefore are strategies that can help you reduce these taxes: –
- Installment Sales–You can stay on the lower rung of the taxation ladder by spreading out the proceed of your sales over many years.
- Long-Term Holding – You can hold the property for more than a year to qualify for lower long-term capital gains taxation.
- Opportunity Zone Investments – Look out for areas that are designated as Opportunity Zones so that you can defer and possibly minimize capital gains taxes.
Staying Compliant and Seeking Professional Guidance
Taxation policies and laws change so frequently that one may end up confused more so with the complexities of real estate as it pertains taxation. It is recommended that youengage a professional real estate tax planning service in order to stay compliant. Also ensure that you document your expenses, keep proper records and stay abreast of changing taxation policies.
To ensure that you are taking full advantage of state tax laws, go for a firm that understands the state’s tax laws. So, a real estate investor or owner with properties in Los Angeles should ideally look for the best real estate CPAs in Los Angeles. You can then be sure that they will have a good grasp of whatever state laws may affect you.
Conclusion
You cannot successfully run a property investment business without at least a basic understanding of tax planning. That is why we have shared the above information to help you get started. Make sure you are always proactive, and always reassessing different strategies to explore. With due diligence, you are sure to maximize savings and profit.
