Better Understanding Tax Benefits?

Question

Hello BP,

I am a prospective investor that has been on the search for an investment multifamily for the past year+. I keep reading that there are many tax benefits to real estate investing but am confused to what they actually are, especially pertaining to rentals. I understand things such as 1031 exchange and writing off depreciation and improvements made, but what other tax advantages does it provide?

I.e. do you pay taxes on all the rental income you collect for the year?

Thanks!

Theo Hicks · Answer

You pay taxes on gains, but when the depreciation is more than the annual rental gains, you won't have to pay taxes. There is also the cost segregation, which is a form of accelerated depreciation. And you mentioned the 1031 exchange, which allows you to delay capital gains. If you pass the last 1031'd property onto an heir, the gains are effectively eliminated!

Greg Dickerson · Answer

@Matthew Gardner it is primarily depreciation most people are referring to especially accelerated depreciation.

Then you have self directed IRA, Roth IRA, 401k etc.

Best thing to do is talk to your accountant and or tax attorney to discuss other advantages.

Denise Evans · Answer

@Matthew Gardner, Rental properties offer you two types of tax advantages. There are those available to investors, such as depreciation (including component and accelerated depreciation methods) and 1031 exchanges, and the ability to hold real estate in an LLC and gift out fractional interests for estate planning or income shifting reasons, but still retain control of the asset.

There is also the ability to refinance and suck out equity for other investments, without it being a taxable event.  It's not like selling the property and using the increased appreciation to buy other things. You can refinance and do the same thing.

Then there is the business side of rental properties, which lets you deduct many business related expenses (home office, supplies, mileage, etc.) and Section 179 vehicle purchase expenses (and other equipment, for that matter) that are not deductible for purely passive investments.

If you hold title in an LLC you can distribute out some income as self employment income, on which you will owe self employment taxes. The excess, over and above the reasonable value of your services each year, can be a simple distribution which is subject to income taxes, but not to self employment taxes.

It is virtually impossible to hold rental properties in a self-directed IRA or ROTH because of the requirement that you cannot guarantee the mortgage loan and you cannot manage the property and you cannot infuse additional capital if there are cash flow shortfalls.  Usually, people hold title in an LLC and then let their IRA or ROTH passively invest via shares of the LLC.  If you do that, then income earned by the IRA or ROTH is not currently taxable. If you hold in a traditional IRA, all distributions are taxable at ordinary income rates when you reach that age.  If you hold in a ROTH, distributions are not taxable.

Basit Siddiqi · Answer

@Matthew GardnerThere are too many tax benefits to mention in just one post and in such great detail.You should research the following termsDepreciationCapital gains tax treatment on sale of rental propertyQualified opportunity funds / qualified opportunity zones1031 like kind exchangescost segregation analysisbonus depreciation / 179 expenseStep-up in basis at deathEtc

John Morgan · Answer

@Matthew Gardner

Yes you pay taxes on the rental income you make (or claim). However, you get to deduct mortgage interest, depreciation, expenses (any receipt you have from Home Depot), mileage, taxes and insurance. So after all this, you’re probably showing a slight loss or slight gain for your properties. And the beauty of it is someone is paying down your mortgage, it’s appreciating 3-5%/year in value and your positive income you make after paying all this is basically tax free..even though you’re showing a loss!

Taylor L. · Answer

@Matthew Gardner many tax advantages are only available to Real Estate Professionals. Judging by your picture, it seems unlikely you currently qualify! As Greg said, it's well worth talking to a well-qualified CPA who understands real estate investing, particularly if you're a high income individual already from your day job.

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