Real estate investment can offer more than a steady passive income and long-term appreciation. One often overlooked advantage is the substantial tax benefits that come with it. Understanding these benefits can significantly impact your overall return on investment (ROI) and long-term financial health. Discovering the tax benefits of real estate investing can provide valuable insights and practical tips to help you maximize your gains.
Understanding Depreciation
Depreciation is a non-cash expense that allows property owners to spread the cost of a property over its useful life, typically 27.5 years for residential properties (including multi-family apartments) and 39 years for commercial properties. This expense can be deducted annually, reducing your taxable income.
For example, if you purchase a rental property for $275,000, you can deduct $10,000 per year as depreciation ($275,000 divided by 27.5 years). This deduction can significantly lower your taxable income, increasing your net cash flow.
Accelerated Depreciation
Although the base IRS depreciation for a multi-family investment is 27.5 years (39 years for a commercial property), an opportunity to depreciate some of the asset faster could be available. By having a cost segregation study performed by a licensed professional, there could be components of the property that could be depreciated on a faster schedule. Things like carpets/flooring, appliances, equipment, and land improvements such as parking lots, might be able to be depreciated on a faster schedule of 5-15 years. This can significantly increase the amounts of tax depreciation that can be taken to reduce your tax on passive income.
Bonus Depreciation
Here enters the beauty of the Tax Cuts and Jobs Act of 2017 (TCJA). This provides for assets with less than a 20 year to depreciation to be depreciated by 60% in the first year of election (in 2024). This bonus depreciation, currently 60% in 2024, is being phased out and will be reduced by 20% each year until reaching zero in 2027.
Mortgage Interest Deductions
Interest paid on a mortgage for a rental property is fully deductible. This can be one of the most significant deductions for real estate investors. The interest paid on a mortgage can often exceed the rental income, especially in the loan’s early years, providing substantial tax savings.
For instance, if you have a mortgage with an annual interest payment of $15,000, you can deduct this amount from your rental income, reducing your taxable income. This makes the cost of borrowing cheaper and enhances your investment returns.
Property Tax Deductions
Property taxes are another significant expense that can be deducted from your rental income. Local governments generally levy these taxes, which vary widely depending on the property’s location.
For example, if your annual property tax bill is $5,000, you can deduct this amount from your rental income. Similar to mortgage interest, this deduction can help lower your taxable income and increase your net cash flow.
Operating Expense Deductions
Costs in managing and maintaining a rental property can be deducted as operating expenses. This includes repairs, maintenance, property management fees, utilities, insurance, and other necessary costs to keep the property operational.
These deductions can significantly lower your taxable income, making your investment more profitable.
1031 Exchange Benefits
A 1031 exchange, named after Section 1031 of the Internal Revenue Code, allows you to defer capital gains taxes by reinvesting the proceeds from a property sale into a “like-kind” property. This deferral can continue indefinitely, allowing you to build substantial wealth without paying capital gains taxes.
For example, if you sell a property for a $100,000 gain and reinvest the proceeds into a new property through a 1031 exchange, you will only pay taxes on that gain once you sell the new property. This strategy can be a powerful tool for growing your real estate portfolio. Sophisticated real estate investors often use this strategy to roll their investments over into a new property to defer their taxes on the sale. One additional benefit is that once you die, your heirs could inherit the property at its market value, using that as their new depreciable tax base. In this case, all of those deferred gains would be wiped away and future depreciation would reset at this higher amount.
IRS – Real Estate Professional Status
Certain investors may qualify as a real estate professional for IRS purposes if they materially participate in a real property trade or business. This could enable them to use rental losses to offset other sources of nonpassive ordinary income (e.g., wages or commissions). However, in order to qualify for this status they will have to satisfy certain requirements under the tax code. It is important to work with a certified tax professional in determining whether you meet this status, and to keep very good records of your real estate activities to qualify.
Final Thoughts
Real estate investing offers numerous tax benefits that can significantly enhance your returns and build long-term wealth. By understanding and leveraging these benefits, you can optimize your investment portfolio and achieve greater financial success.
Ready to maximize your real estate investment returns? Gain insights into our available investment opportunities while understanding your financial goals, risk tolerance, and investment horizon. We aim to assist you in reaping the benefits of owning real estate passively, all without the associated stress. Through our collaborative approach, we can identify which opportunities align well with your specific investment needs. Passive real estate growth can begin with a simple conversation. Reach out today to discuss how we can help you embark on a rewarding investment journey that enhances your financial future and your peace of mind.
Disclaimer
The information provided herein is for informational purposes only and should not be construed as tax advice. Tax rules can be complex and subject to change, and individual circumstances may vary. We strongly recommend consulting with a Certified Public Accountant (CPA) or a qualified tax advisor before making any decisions that may impact your taxes. We are not qualified tax professionals and do not offer specific advice regarding tax matters.