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7 Tax Benefits of Real Estate Investing

7 Tax Benefits of Real Estate Investing

While real estate paves the path to lucrative returns, it’s also a treasure trove of tax perks.

Imagine squeezing more profit from your investments, not just through strategic buys or high rent, but via keen tax strategies.

If you’re not diving deep into these benefits, you’re leaving money on the table.

Are you ready to enjoy the ample tax benefits up for grabs? Join us as we walk you through each of these impressive perks! The world of real estate investing is about to get so much more exciting.

1. Depreciation: The Gift That Keeps on Giving

When people think about real estate, they often visualize its appreciation in value. But from a tax perspective, depreciation is the star of the show.

Buildings and improvements naturally wear out over time. However, this deterioration isn’t a bad thing on paper.

The IRS allows real estate investors to deduct a portion of the cost of a property over a predetermined number of years (a concept known as depreciation). For residential properties, this is usually spread over 27.5 years.

So, how does this work? Let’s say you’ve purchased a rental property for $275,000. Excluding the land value, you might be able to write off $10,000 annually ($275,000 ÷ 27.5 years) against your rental income. Over time, this deduction can substantially reduce your taxable income, leading to considerable savings.

However, note that when you sell the property, you might need to recapture some of this depreciation. But with smart planning and by leveraging real estate loans for further investments, you can continually harness this tax benefit and structure your assets optimally.

Recommended Read: How to Manage Multiple Income-Producing Properties Like a Seasoned Pro

2. Interest Deductions

a real estate investor tracking his investment

Interest is a significant expense for many real estate investors, especially for those leveraging real estate loans to expand their portfolios.

But here’s the silver lining: the interest you pay on these loans is often deductible. Whether it’s for purchasing, building, or improving your property, the interest from these mortgages can be written off.

If you’re a real estate investor with a home equity line of credit, the interest from this can also be deductible, provided it’s used exclusively for buying, building, or substantially improving your property.

This can significantly reduce your annual tax bill, making your investments more profitable in the long run.

3. Long-Term Capital Gains

Every investor relishes the moment they sell a property at a profit. But the celebration comes with the dreaded capital gains tax.

Here’s some good news: if you hold onto your property for more than a year before selling, your profits are taxed at the long-term capital gains rate, which is notably lower than the ordinary income tax rate.

For instance, if you fall into the 10% to 15% tax bracket, you could be paying 0% on your long-term capital gains. Those in higher brackets still enjoy reduced rates compared to ordinary tax rates.

By strategically planning the duration of your investments, and sometimes leveraging refinancing options through real estate loans to hold onto properties longer, you can maximize your returns and minimize your tax liability.

And remember, there are strategies like the 1031 exchange (more on this next) that allow you to defer capital gains tax by reinvesting the proceeds from a sale into a “like-kind” property, further emphasizing the tax-savvy nature of real estate investing.

Recommended Read: The Right Time to Use Fix and Flip Loans for Your Investment Strategy

4. The 1031 Exchange

Aptly named after Section 1031 of the IRS Code, the 1031 exchange is seasoned real estate investors’ favorite tool, and for good reason.

This provision allows you to defer capital gains tax by rolling the profits from the sale of one property directly into the purchase of a similar, or “like-kind,” property. Instead of cashing out and facing a hefty tax bill, you’re reinvesting, and the tax obligations are deferred.

Let’s say you’ve just sold an apartment building. Instead of paying taxes on the profit, you decide to invest in another property. By using the 1031 exchange, you can effectively delay the tax bill and leverage the full profit to secure a more valuable or profitable property.

However, this isn’t an endless game of tax-free monopoly. There are specific rules and timelines to follow. For instance, from the date of sale, you have 45 days to identify the replacement property and 180 days to complete the purchase.

5. Passive Activity Losses

a real estate investor planning his next real estate investment

You won’t always win when you dip your toes into the real estate investing waters. Sometimes, properties underperform, or unexpected expenses arise, leading to losses. This is where passive activity losses (PAL) come into play.

These are net losses from rental real estate activities. The IRS allows certain taxpayers to use these losses to offset other passive income sources.

For many investors, especially those just getting started, real estate can be treated as a passive activity. If your adjusted gross income (AGI) is $100,000 or less and you actively participate in managing the property (like making management decisions or approving expenses), you can deduct up to $25,000 of your real estate losses against other sources of income.

For those with higher incomes, the ability to take this deduction decreases and phases out entirely for an AGI over $150,000. Still, with strategic financial planning, passive activity losses can be a beneficial tool in your tax arsenal.

Recommended Read: Real Estate Loan Myths Debunked: Setting the Record Straight

6. Property Tax Deductions

Here’s a silver lining for real estate moguls: you can deduct property taxes tied to any real estate you own. These deductions can be particularly helpful in areas where property taxes tend to be on the higher side.

Each year, you can write off the entire amount of property taxes you’ve paid on any number of investment properties. However, this doesn’t apply to any portion of your taxes that might be allocated for services or assessments that increase the value of the property.

In essence, while property taxes can be a significant expense, they also offer an avenue for deductions that can balance out your taxable income.

7. Rental Expenses

When it comes to real estate investing, rental properties are often the first port of call for many. They’re tangible, they’re relatively straightforward, and they can generate a stable income stream.

The icing on the cake? Almost every expense associated with managing and maintaining a rental property can be deducted from your taxable income. These deductible expenses are broad-ranging and include:

1. Mortgage Interest: This isn’t exclusive to your primary residence. The interest on the mortgage of your rental property? Deductible.

2. Maintenance and Repairs: Whether you’re fixing a leaky faucet, repainting the exterior, or servicing the HVAC system, the costs can be deducted. However, significant improvements (e.g., a property extension or a new roof installation) are treated differently and usually depreciate over time.

3. Insurance: Any insurance premiums related to your rental property can be counted as a tax-deductible expense.

4. Travel: If you travel for the purposes of your real estate activities, those costs can be deducted. This includes trips to check on your property, meet with tenants, or even travel to buy supplies for repairs.

By meticulously tracking these expenses, investors can significantly reduce their taxable income and, by extension, their tax liability.

Recommended Read: 10 Questions You Should Ask Your Lender Before Taking Out a New Construction Loan

Start Working with InstaLend!

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The real estate landscape isn’t just about buying low and selling high. It’s also about strategic tax benefits that maximize your ROI. And while taxes may never become your favorite subject, the right knowledge can make them a whole lot less taxing!

If you’re ready to start reaping the benefits of real estate investing, including these golden tax benefits), InstaLend should be your first stop. We help you acquire the funds you need to launch a power-packed real estate project.

At InstaLend, we provide fix and flip loans, single-family rental loans, new construction loans, multi-family bridge loans, and multi-family term loans to both novice and seasoned investors.

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Disclaimer: This article should not be interpreted as tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

  • November 14, 2023
  • 7 min read
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