What are the tax benefits of owning real estate?

15 Replies

I was wondering what the tax benefits were of owning real estate? I know it is agreat investment, but I wonder what all the little details were. :mrgreen:

It probably has something to do with all of those big fat dedcutions you get to take ;)

I'm going to take a view that many others WON'T agree with, but I think I can refute their "tax advantages" point-by-point.

1. You get to "write off" your expenses! I don't consider this an "advantage" to REI, after all you can do this with any other investment as well. Often a big expense of RE is interest. Let's see, you pay your bank with one hundred cent dollars in order to avoid paying the government with 25 cent dollars. Huh.

2. Depreciation! Well you have to recapture it when you sell, and you will eventually sell.

Most tax benefits (since the tax reform of '86) only accrue to LOSSES. If you're in REI to generate losses you won't be in it for long!

There is one (although you have to cheat to get it) "tax benefit". If you're working on your own residence and you go to HD and spend $1500 or so, the receipts for that could ACCIDENTALLY fall into the file where you keep your receipts for your rental units. Thereby creating an adjustment to you net taxable income that wouldn't have been there before.

Just my opinion on this stuff, although mine is backed up by facts.

all cash

Originally posted by "all cash":
I'm going to take a view that many others WON'T agree with, but I think I can refute their "tax advantages" point-by-point.
Well then let's get started with a healthy debate.

Originally posted by "all cash":
1. You get to "write off" your expenses! I don't consider this an "advantage" to REI, after all you can do this with any other investment as well. Often a big expense of RE is interest. Let's see, you pay your bank with one hundred cent dollars in order to avoid paying the government with 25 cent dollars. Huh.
A couple of things here. I would agree if you said "I don't consider this an advantage to REI because you can do this with any other business". When I own a business I get to start paying for things with pre-tax dollars and it adds up. I mean how many of you need a cell phone to operate your business? Well, isn't it nice to get an automatic 25% off your cell phone bill? So you're right that it's not unique to REI, but it's an easy way for the average american (with a day job, no other businesses) to increase their income.

As far as interest goes... well it's nice if you don't need money for loans, but some of us aren't as well off as you are (yet ;)). Beyond that basic finance principles show how leverage can increase your returns, IF you can achieve an ROI that is significantly higher than your cost of capital.

Originally posted by "all cash":
2. Depreciation! Well you have to recapture it when you sell, and you will eventually sell.
Ever heard of a 1031 exchange? Check it out via google and/or the IRS website. It is entirely possible for you to fully depreciate a building, sell it, buy a new building, and never pay taxes on the gain from the sale of the first building.

Originally posted by "all cash":
Most tax benefits (since the tax reform of '86) only accrue to LOSSES. If you're in REI to generate losses you won't be in it for long!
I'm not 100% sure what you mean by "only accrue to LOSSES". Are you talking about tax loss carryforwards?

In any case it is 100% possible for you to have LOSSES for 20 years, but to have positive CASH FLOW for each of those years. In fact, this should be your goal. If you're leveraging your purchases by using debt financing then this is possible with almost all value / bargain purchases.

"Cash flow" is king. If you are trying to evaluate a property you want to look at "discounted cash flows" (google it if you don't know, it's basic finance, but critical to understand).

"Net Income" is important... but there is a difference between "Net Income" and "Taxable Income". A good accountant will explain this difference further if you like. PM me if you want.

Originally posted by "all cash":
There is one (although you have to cheat to get it) "tax benefit". If you're working on your own residence and you go to HD and spend $1500 or so, the receipts for that could ACCIDENTALLY fall into the file where you keep your receipts for your rental units. Thereby creating an adjustment to you net taxable income that wouldn't have been there before.
I won't suggest you do the above... although some people certainly do. But consider the following list of household expenses that could legitimately be expensed:

- rent (if you use office space in your home you can take a percentage of your home mortgage / value)
- cell phone
- lawnmower
- tools (home improvement tools, obviously)
- computers
- software (although really there is a lot of great FREE software out there if you know where to look... but that's another topic for another day)
- internet connection
- vehicle (but be VERY careful about this if you plan on doing it)
- gas for the lawnmower
- business lunches

... and more. The above is a list of things that you would legitimately need for a business and you could legitimately write off on your taxes. All cash, do you have a CPA that does your taxes for you? You should seriously consider hiring one as they can put a big dent in your tax bill.

Finally remember: there is a HUGE difference between "Tax Evasion" and "Tax Aggressive". You can be aggressive without actually breaking the law... or you can be conservative and give more of your money to the government. Personally, though, I prefer to keep as much of my money as I (legally) can.

That got a bit long-winded didn't it?

i don't think you are allowed to deduct depreciation of land as an expense in accounting... maybe you are talking about a differnet context :beer:

No, you cannot depreciate land! However, you can depreciate the building(s) on the land. So if you only plan on developing land then this isn't going to be a tax benefit for you.

Always talk to a qualified CPA... they can save you big $$$ by being tax AGGRESSIVE, not tax EVASIVE. This is a fine line and any good CPA will be able to explain the difference to you. If (s)he can't, then you need to find a new CPA.

you can not depreciate land but you can depreciate land improvments such as roads, drainage etc..

I have many clients who have made substantial fortunes in the real estate business and for many years paid very little tax because of depreciation. Yes it is true that there is a recapture on depreciation but it is at a maximum of 25% which is still less that the maximum tax rate for an indivual.

I have a CPA firm in NY that specializes in working with people in the real estate business. I would be happy to try to answer any questions that anyone has.

Land improvements are depreciated over 15 years straight line. Buildings are depreciated over 27.5 years for residential and 39 years for commercial straight line.
You only have depreciation recapture on accelerated depreciation for buildings and now you can not accelerate depreciation on a building, nor land improvements. There is not any depreciation recapture on your personal property.

Point blank - benefit for RE investment is positive cash flow and a paper tax loss.

I am surprised that nobody mentioned that. But if you are a landlord, you don't have to pay self-employment tax (Social Security & Medicare), which constitutes a tax saving (currently) of 15.3%. This is one of the great tax benefits of owning rental property. However, if you provide substantial services with your rental (like bed-n-breakfast, motel, hotel) you do have to pay this tax. That's the only exception to the rule.

I have to disagree with all cash regarding the statement you will eventually sell. Investors can continue to exchange throughout their lifetime (swap until you drop) and never sell. The strategy is to accumulate wealth with cash flow and then leave the wealth to your heirs. Your heirs will inherit the property at a "step-up" in cost basis equal to the fair market value of the property at the date of death.

I can see both sides of this...

If 'Allcash' is saying you shouldn't buy a property just for taking the losses. You better look at cashflow. I totally agree with that.

However for most people that have a few investment properties and are working or doing something else as their main occupation. RE Investment has a lot of benefits:

1> Pre-Tax deductions of some expenses as was mentioned earlier. It gives you some of the benefits of business owner without having left your job.
2> Depreciation which get recaptured at the capital gains rate rather than your income tax rate, which is higher in most normal situations.
3> Accelerated depreciation if you segment short-life assets. Bigger deductions upfront.

Thanks.

There are several favorable tax advantages of owning real estate. While it isn't as good as other investment opportunities, real estate offers a nice way to shelter cashflows (depreciation) and cash spent on improvements. However, any improvements you make are depreciated over the useful life of the improvement, which is often many years.

I am just starting my real estate investment, got a question on the tax thing you are talking about, do I have to set up a LLC to take advantage of the deductions such as office use, cell phone..etc??

Thx a lot!!!

You should definitely set up a formal entity. If you are truly serious about investing in real estate, than it is inevitable. I like the LLC structure, but others like C-corps and even S-corps. If you are going to be working with partners who are contributing capital to your new business, you may want to look into a Limited Partnership. There are many options and a lot of free information out there.

If you are going to own property in which someone else lives, then you MUST incorporate. I like Nevada and even better, Wyoming, for incorporation as it keeps your information private. You can also accomplish this by use of a nominee director.

I believe Nevada is better than Wyoming.

Find an accountant that DEALS WITH REAL ESTATE. I know this from past experience you can save money. I was told by my accountant that I will need a few different entities for different ways to do REI. My advise to you will be get a list of accountants from yellowbook.com write down what your going to be doing in your business and ask for a meeting face to face to see if they area right for you. but have all your ducks in a row.

Oh and about that tax advantage for owning a home thing yeah you get a break but you need to spend 6,000 to get 1,200 back Doesn't really make alot of sense. I"m in a situation were I can pay off my primary home. Not 100% sure if that is what i'm going to do. I think that is the best Thing I can do, but I need to research it some. what if interest rates jump to 10%

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