It’s a good idea to diversify your investments. It is a common notion that investing in rental properties can generate recurring, dependable income. But did you also know that it can also be beneficial to your taxes?
Real estate remains a popular investment strategy for those looking to protect and grow their wealth. In addition to the opportunity to generate cash flow, investing in real estate offers a treasure trove of tax benefits.
Nevertheless, maximizing your opportunities requires a thorough understanding of what’s available. You can maximize your yearly return on real estate investing by learning about the many tax benefits below.
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Do Real Estate Investors Get Tax Benefits?
Real estate investing comes with many tax-saving benefits that go far beyond earning extra income. Buying a house or multifamily investment property can also be a great way to save on taxes.
So, is it good to invest in real estate now? Definitely! In addition to growing equity and collecting rent, real estate investments have many other benefits. The following are a few of the notable tax benefits that you should know about.
Abundant Tax Deductions
Investing in real estate provides investors with the opportunity to deduct or depreciate every conceivable expense they encounter. You can take advantage of these “above the line” deductions by deducting them from your rental income. As a result, you don’t have to itemize your deductions since they are taken out of your gross income before calculating your taxes.
Investment in real estate has many tax advantages, one of which is the ability to deduct expenses relating to a rental, such as:
- Property taxes
- Property insurance
- Mortgage interest
- Property management fees
- Building maintenance and repair costs
Are you aware that the expenses you incur running your real estate investment business can also be deducted? There are several expenses that are considered qualified business expenses, including, but not limited to:
- Office space
- Business equipment (e.g., computer, stationery, etc.)
- Accounting and legal fees
- Travel fees
In order to maximize your return, you must determine the most valuable deductions. You can, for instance, only deduct 50% of meal expenses or $5 per square foot from home office space.
However, other fees can provide valuable tax advantages, such as capital improvements depreciable over time and business-related travel costs when you do not have a fixed place of business.
Suppose you could deduct the purchase price of new rental property from your taxable income. You would have more money in your pocket, right? There’s no way to do that exactly. However, depreciation is not far off.
Assumed wear and tear contributes to depreciation, which is the progressive loss of value of an asset. Tax deductions due to depreciation are available to real estate investors who own rental properties that generate income. As a result, you may have a lower tax liability and lower taxable income.
Property owners buy two things when they buy rental properties: the land and the building on it. While land doesn’t rust or crumble or become outdated, buildings do, which is why the IRS enables real estate investors to depreciate the cost of the building over 27.5 years.
The process can be compared to having a tax deduction spread out over a number of years.
Passive Income and Pass-Through Deduction
In real estate, passive income is money earned from business activities in which investors are not physically involved. Rental income earned from investment properties is the most common form of passive income.
Passive losses were the only way rental property investors could offset passive income before 2018. But with the passage of the Tax Cuts and Jobs Act of 2018, passive income investors gained some benefits.
As a result of the Tax Cuts and Jobs Act of 2017, real estate investors, small business owners, and self-employed professionals can now take advantage of a tax deduction that is beneficial to them. Generally, this deduction is called the qualified business income deduction (QBI) or the pass-through tax deduction.
Taxpayers who earn QBI, which includes rental income, can deduct up to 20% of their taxable income. Pass-through deductions allow them to do so. Quite a significant reduction, as the effective income tax rate is lowered by 20%.
Capital Gains Tax
When the advantages of investing in property are discussed, it is likely that capital gains tax will be mentioned. When you sell an asset that has grown in value, you may be required to pay taxes on the profits. This may apply to single-family homes, multifamily residential properties, apartment buildings, condominiums, and other properties.
In general, capital gains tax is calculated on the appreciation of your investments, but the amount you pay can also vary based on your income, the length of time you own the asset, and your tax status.
Depending on your taxable income, capital gains tax may range from 0% to 15%, or it may jump to 20% beyond certain present thresholds. Furthermore, it depends on how long you’ve owned the assets. Listed below is a comparison of short-term and long-term capital gains.
Short-Term Capital Gains
In short-term capital gains, you earn profits on assets you’ve held for a period of 12 months or less.
Since capital gains are taxed as general income, they can negatively impact your taxes, as they are taxed according to your marginal tax rate. However, if you sell the asset a year before recognizing these gains, you would be considered to have long-term capital gains instead.
Long-Term Capital Gains
Profits from assets held for more than one year are called long-term capital gains. As compared to marginal tax rates, long-term capital gains are generally taxed at a rate of 15-20% compared to short-term capital gains. This savings opportunity generally makes it worthwhile to hold onto investments for a little longer.
Why Real Estate Tax Benefits Exist
The tax benefits of investing in real estate are numerous for current and aspiring investors. It doesn’t matter whether you’re buying a single rental property or expanding a multifamily or multiunit portfolio, there are numerous tax deductions to take advantage of.
Overall, we’ve seen a lot of tax benefits resulting from multifamily properties. The government provides these incentives to encourage investors to provide affordable housing.
As a result of these many advantages, you should consider how prospective tax breaks can be incorporated into your financial planning when structuring investments.
Check out Saint Investment’s real estate investing guide to learn more about the various ways you can invest in real estate and why some methods will be better than others for your portfolio. For more free resources in investing, visit our website today!
President of Saint Investment Group
Nic is a two decade seasoned expert in investing and capital raising, specializing in Real Estate and debt markets. With Saint Investment Group, he leads large-scale distressed asset purchases and innovative syndications for investors.