Americans may be quick to propose higher taxes for other people, but we’re less enthusiastic to pay higher taxes ourselves.
Fortunately, the U.S. tax code allows plenty of options to reduce your tax bill. It does require you to actually pay attention, form a tax strategy, and plan ahead—which most Americans aren’t willing to do.
As the year draws to a close, consider the following financial moves to slash your tax bill and keep more of your hard-earned money in your own pocket instead of Uncle Sam’s grasping paws.
Harvest Losses to Offset Gains
The IRS charges you capital gains taxes on the net sum of your long-term gains and losses. So in a year when you rake in particularly high gains, you can avoid capital gains taxes by offsetting those gains with losses.
No, that doesn’t mean you should go out and intentionally buy bad investments to lose money. But none of us are prescient investors that get every investment right; we all make mistakes. And years when you bring in high gains make great opportunities to acknowledge those mistakes, cut your losses, and reinvest the money in better long-term investments.
Say you sold a long-term rental property this year for a $25,000 profit. You don’t love the idea of paying capital gains taxes on $25,000. So you look at your stock portfolio to review your stocks’ performance.
You notice a few underperformers that just haven’t worked out the way you thought they would. You could wait around for another three years, hoping they turn around. Or you could acknowledge you lost that round, sell them, and reinvest them in index funds or rental properties or through a robo-advisor or some other strategy altogether.
You sell them for a $5,000 loss, which drops your taxable gains to $20,000. You still owe taxes, but less than you did before, and you cleaned up your investment portfolio and put your money where it will work harder for you.
Contribute to a 529 Plan
Many states allow you to deduct contributions made to a 529 plan, which can be used to help fund your children’s college education. But in most cases, these contributions must go out by December 31.
Note that 529 contributions are not deductible on your federal income tax return. They work like Roth IRAs, where the contributions grow tax-free, and you pay no taxes when you withdraw them.
Also, bear in mind that the IRS allows you until April 15 to make contributions to 401(k)s, IRAs, ESAs (an alternative college savings account type), and health savings accounts (HSAs). And if you invest through a self-directed IRA, you can even invest in real estate through it!
Make Charitable Donations
Giving money or assets to charitable organizations not only helps you save money on taxes, but it also lets you give back and invest in the future of our world. Plus, it paradoxically makes you feel richer to give money away.
On the tax side, however, you should note a few caveats.
First, the average person can only deduct for charitable contributions if they itemize their deductions. If they take the standard deduction, then they don’t bother tallying up their deductions at all.
Unless, of course, you own a business—which you probably do as a real estate investor. Look into making your charitable gifts through your business, so that it comes off your business’s bottom line, and therefore is not taxed. That way, you can still take the standard deduction in your personal tax return and still pay no taxes on your charitable contributions.
You can even donate entire real estate properties, cars, or other large assets if you wish, and avoid the hassle and expense of marketing and selling them.
As a final thought, beware that claiming high charitable donations can trigger an IRS tax audit. Too many people try to pull one over on Uncle Sam by overstating the value of their donations, so he’s grown jaded about high gift claims.
Prepay Business Expenses
If you pay a bill this year, it comes off of this year’s taxable income—even if the bill isn’t due until next year.
For example, you can prepay your January mortgage payments on your rental properties. And, for that matter, on your home if you itemize deductions rather than taking the standard deduction. Just make sure your mortgage lender knows to apply the payment as your January payment, rather than as a principal paydown. Some online payment portals allow you to select this, but if not, make your payment by phone and confirm that the payment will be applied as your regular monthly payment.
Similarly, many software and subscription services let you prepay a year in advance. Some even offer hefty discounts for annual rather than monthly payments. Still others charge by the service or product, which you could purchase now rather than in January. Software and service examples for real estate investors include BiggerPockets (of course!), Propstream, and Stessa.
If you think you’ll need to pay for it anyway, pay it now to lower your taxable income.
Prepay State & Local Tax Bills
The same concept applies to tax payments.
Self-employed Americans—like, say, real estate investors and agents—owe estimated quarterly taxes on their incomes. This includes taxes to state and local governments, if you haven’t moved to a lower-tax state yet, to avoid hemorrhaging thousands of dollars in income taxes each year.
The fourth quarter estimated tax payment is due by January 15, but you can pay it early in December. That way, you can deduct the state and local tax bill on your federal income tax return.
Beware, the federal government caps state and local tax (SALT) deductions at $10,000 per year. But if you haven’t reached that threshold, you can also do things like prepay your home’s property taxes to deduct it this year.
Squeeze in Medical Payments
The IRS allows you to deduct certain healthcare expenses if they surpass 7.5% of your adjusted gross income.
Sum up your total healthcare spending for this year. If you’re near the 7.5% threshold, now makes the perfect time to visit the dentist or specialist you’ve been procrastinating on or to get that necessary procedure you’ve been postponing. That can push you over the 7.5% threshold, allowing you to deduct the expenses.
For that matter, the same logic applies if you’ve already passed the 7.5% threshold. Knock it out this year, while it’s deductible!
Do Property Maintenance & Repairs
While some property repairs must be depreciated over time (more on those shortly), you can deduct the costs of maintenance in the same year.
For example, does your property need repainting? Knock it out now to reduce your taxable income for that property.
As a general rule, maintenance and repairs are work that’s necessary to keep a property in good living condition, rather than extending the lifespan of the building. The cost of maintenance adds up quickly for landlords, however, and the end of the year makes a great time to do necessary work and lower your tax bill.
Make Capital Improvements
Capital improvements to a property improve its usable lifespan. Rather than deducting the entire cost in one year, you have to spread the deduction over 27.5 years as depreciation.
For instance, if you replace all the wiring in a property, that counts as a capital improvement. The same goes for updating the HVAC system, plumbing, or replacing the roof.
The line between repairs and capital improvements sometimes gets blurry. Say a baseball goes through a window, and you replace it—that clearly qualifies as a repair. Or say you replace all the aging windows in a property—that clearly qualifies as a capital improvement. But what if you replace a few windows that weren’t technically broken but were rather leaky?
When in doubt, talk to your accountant about what qualifies as a capital improvement versus a repair or maintenance cost.
No one wants to pay more taxes than absolutely necessary. I went so far as to move overseas, where my wife and I use the foreign earned income exclusion to avoid most U.S. income taxes. (I still have to pay self-employment taxes as an entrepreneur, though.)
You don’t have to go to that extreme, although there are certainly other perks to living overseas, such as lower cost of living, more affordable (but equally excellent) healthcare, and affordable childcare. But by paying more attention to your tax strategy, especially in December, you can lower your tax bill and tell Uncle Sam to go shake money out of someone else’s pockets.
How do you lower your income tax bill as a real estate investor?
Share with a comment below.