As a CPA a common question I am asked is: “How can I create a tax shelter using my real estate?” Let’s be honest: most of us, including me, do not have overseas bank accounts that allows us to shelter large amounts of income from taxes.
If you are not in the Swiss bank account club, there is no need to worry. It might actually be to your benefit because recently, the U.S government made a treaty with Switzerland to team up together to find and prosecute tax evaders.
You don’t have to open a bank account overseas just to shelter your hard earned money. There are plenty of other ways to be an honest tax payer and take advantage of tax loopholes and strategies. Let’s take a look at some legal tax havens available to real estate investors just like you.
5 Clever (& Legal) Tax Strategies to Save Real Estate Investors Money
Your Home is Your Best Tax Shelter
If you own your home, great news – you are already providing yourself a great tax shelter! The moment you purchased your home, you write away received tax benefits. Your mortgage interest provides you with tax deductions by itself.
Even better news is that if you sell your home and make profit, Uncle Sam may not be able to touch that money. The IRS allows you to sell your home and not get taxed on up to $250,000 of profit if single — and up to double that if married. The main requirement is that you need to have lived in the home as your primary home at least two out of the preceding five years. This can be a great strategy, especially if you are trying to grow your equity and trade up every few years.
Be Wise and Invest Wise
You can invest in just about anything or any company these days. The reason I personally choose real estate as my investment vehicle is because it provides me with leverage and cash flow. Another great benefit is you have access to depreciation strategies. This power move allows you to pay a fraction of the total cost of your investment yet still take a deduction for the entire property purchase price.
The 1031 Advantage
Let’s say you purchase an investment property but then decide you want to purchase another. In order to do so without paying any taxes, you can use a tax strategy called the 1031 exchange. This strategy allows you to postpone the taxes owed on the first property and swap it for another property. This is also known as a like-kind exchange.
A 1031 exchange means you can avoid tax on any capital gain on the property by rolling the proceeds of the first property into your second property. Once you are ready to sell the second property, you can use this same strategy again to purchase your third property. A tax free loan from Uncle Sam doesn’t sound too bad, does it? Make sure to speak with your tax advisor and see if a 1031 exchange works for you.
Business Tax Loopholes
Believe it or not, your real estate is a business when it comes to taxes. I am not talking about an LLC or a Corporation. I am talking about the fact that your real estate is a business for tax purposes and may allow you to take advantage of a lot of the tax deductions available to businesses.
Whether you run your real estate business full time or part time, there are business tax shelters available to you. One strategy is to deduct the business use portion of your car, phone, equipment and or home office for your real estate. If you qualify for a home office, you are even able to make repairs on your home and deduct the percentage that is used for your business.
Income Shifting Strategies
One more strategy that is essential is to make sure you are paying your kids or spouse if you are able to find something for them to do for your real estate business. These strategies and more may be available to you as an investor, and your tax advisor should be incorporating them into your overall tax plan. If not, it’s time to reevaluate your working relationship.
As you can see, there are lots of tax shelters that may be available to you as an investor. All you need to know is how to apply them to your unique situation. Work closely with your advisor this tax season to see what opportunities are available to you so you can have all of your strategies in place for 2015.
What tax strategies will you be using this year as an investor? Is there anything I missed?
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.