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The Tax Exemption That Can Save Thousands for Buy & Hold Investors

Ben Lemieux
3 min read
The Tax Exemption That Can Save Thousands for Buy & Hold Investors

One common way for rental property investors to qualify for their first few rental properties is to purchase a home as their primary residence, live in that home for one year, and move out after the year is up — and then turn the home into a rental property.

If you’re a buy and hold rental investor and this is your strategy, don’t forget that during the year that you live in that home, you may qualify for the homestead exemption.

What is the Homestead Exemption?

The homestead property tax exemption is a government-approved exemption for homeowners that allows you to lower your home property taxes by decreasing your home’s taxable value. The exemption removes a portion of the value of your property in order to lower your taxes.


Types of Homestead Exemptions

Homestead exemption laws vary by state. Let’s say, for example, that you’re interested in investing in a home in Texas. There are three primary kinds of homestead exemptions that would affect you.

  • Type 1: Homeowners who qualify for the homestead exemption are eligible to receive a minimum exemption of $15,000 on their home’s value for school district taxes.
  • Type 2: Homeowners may apply for a 20% exemption, which lowers the value of the home to lower your annual property taxes.
  • Type 3: Homeowners may be eligible for additional exemptions depending on your particular school district, county, city, or if you reside in a special district. Each body of government makes their own decisions regarding which exemptions they will offer and at what percentage rate. Contact your local governing bodies to discover which other homestead exemptions (if any) you may qualify for in addition to the percentage exemption.

Related: JUST RELEASED: Brand NEW BiggerPockets Book on Real Estate Tax Strategies!

Is the Homestead Exemption Worth it?

Numbers don’t lie. A few minutes of filling out paperwork could equal thousands of dollars in savings. Let’s say, for example, that you usually would pay 2.5% in taxes on the value of your home. On a $250,000 home, this equals paying $6,250 annually in taxes.

With a homestead exemption of 20%, you would only have to pay property taxes on $200,000 of home value, or $5,000 per year. Simply by qualifying for this exemption, you would save yourself $1,250 annually on property taxes.

Who Qualifies for a Homestead Exemption?

Again, homestead exemptions vary by state and type. Let’s say, however, that you bought a house in Houston last year, with the intention of developing it into an investment property while you maintained the residence as your primary location.

If as of January 1, 2016, you are the homeowner of single-family home, townhouse, or condo, and you’re using that property as your primary residence, then you are eligible for a homestead exemption.

In most states, in order to apply, you’ll simply file the appropriate paperwork with your county tax assessor. This generally includes:

  • Filling out a homestead exemption application
  • Providing a photocopy of your current driver’s license with that property’s address listed
  • Providing a copy of your vehicle registration or current utility bill that shows the property address
  • Filing the application and paperwork between January 1, 2016 and April 30, 2016, with mailed applications postmarked no later than April 30, 2016


The Homestead Cap: an Additional Benefit

Another advantage of the homestead exemption is the homestead cap. If your property is in an appreciating housing market (more than 10% appraised value per year), the homestead cap limits the increase in the appraised value of your home and can save you quite a bit of tax money. A homestead cap would become available to apply to your homestead exemption at the beginning of the second year that you qualify for a homestead exemption.

Related: The Ultimate Guide to Real Estate Investment Tax Benefits

If you qualify for the cap, according to most homestead cap laws, your appraised value of your property may not be greater than this year’s market value or last year’s appraised value, with an additional 10% of any value created through home improvement in the previous year.

Save Thousands in Taxes

Homestead exemptions and homestead caps are fairly easy to obtain and may save you a substantial sum in taxes. It certainly doesn’t hurt to apply. Call ahead to your city’s tax assessor and ask which documents they require for a homestead exemption application. By taking a few hours to fill out the paperwork and submit the correct documents, you could very well save yourself thousands of dollars on your investment property.

Investors: Have you used the homestead exemption before? Any questions about the laws surrounding this tax break?

Let me know with a comment!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.