Did you know investing in real estate comes with significant tax benefits? Uncover the top tax strategies for maximum benefit and how to use them during tax time.
As with all deductions, talk to your tax accountant for the most up-to-date information on real estate investing tax deductions.
Self-Employment / FICA Tax
First and foremost, you can avoid payroll tax if you own a rental property. The income from your rental property isn’t considered earned income. In addition to avoiding tax outright, real estate investors benefit from numerous deductions.
Expense Deductions
Property tax, insurance, mortgage interest, maintenance or management fees, and other real estate expenses directly related to your investment are deductible. These expenses are typical deductions the IRS deems “ordinary and necessary” to sustain your real estate investment. However, a few deductions you may be entitled to are often overlooked.
For instance, you may deduct the miles if you travel to and from your investment property. You can also deduct non-mortgage interest fees related to the investment property. For example, a loan or credit card interest incurred with the investment property is deductible. Also, legal and other professional fees directly associated with the investment property are deductible.
Depreciation
A depreciation deduction lowers your taxable income. Suppose you have a real estate investment property that yields income. In that case, you can deduct the depreciation of that property as an expense.
According to the IRS, the life expectancy of real estate is 27.5 years for residential properties and 39 years for commercial properties. These life spans determine the deduction to which you are entitled.
Incentive Programs
Some incentive programs allow real estate investors to defer real estate taxes. For example, when selling an investment property and reinvesting in a replacement property, investors avoid paying capital gains taxes with a 1031 exchange. They can reinvest the proceeds from one property sale into another. The transaction must occur within a specific time to avoid capital gains taxes, which are taxes on the growth of an investment when sold.
Suppose your real estate property is eligible as an “opportunity zone,” a disadvantaged or low-income parcel. In that case, you may be able to defer capital gains tax further, grow your capital gains, or avoid capital gains entirely.
These perks are time-dependent. Seek help from your qualified accountant to navigate them.
Capital Gains
Suppose you sell your real estate investment property and can wait until you’ve held the property for at least one year. In that case, you can pay a lower capital gains tax than if you sold it sooner or avoid capital gains altogether. That’s because holding a property for over a year makes it a long-term investment, and with that, you get to pay a significantly lower capital gains tax rate. You can also avoid the tax if your income is under a certain amount. You should check this information with your accountant, as these rates change yearly.
Qualified Business Income (QBI) Deduction
This deduction encourages entrepreneurship. More commonly known as the pass-through deduction, it lets certain entities deduct up to 20% of their business income. LLCs, S-corps, sole proprietorships, and similar businesses benefit from this. You may be wondering how real estate investors benefit from this type of deduction. If you own rental properties, you operate a small business, by technicality, under IRS standards. Therefore, you are entitled to the QBI or pass-through deduction. It can also benefit real estate investment trust investors (REITs) because they are technically regarded as pass-through entities. The QBI deduction isn’t scheduled to end until 2025, so there’s still time to take advantage of this.
Deductions like QBI, depreciation, expense deductions, and others on this list point that real estate investment can enormously reduce tax liability. Talk to your qualified accountant or CPA to help you navigate these tricky waters of tax deductions. They make it their business to be aware of the latest tax law changes, updates, and deductions. With the right professional help, you can take advantage of all the tax breaks for which you’re legally qualified.
