Why Tax Benefits make Real Estate Investment a Smart Move
A main benefit of becoming a real estate investor is the substantial tax advantage that will put money back in your pocket. Here are some of the basic tax benefits, but keep in mind that tax laws are constantly changing– possibly to your advantage. The best thing to do is speak to a knowledgeable accountant to find out the specifics.
1. Long Term Capital Gains
The IRS taxes your property when you sell it at a profit. Beginning in 2018, if you hold on to the property for three years or less you are taxed at your usual income tax rate, which can be especially significant for high earners. For investors who hold on to their properties for a longer period of time, profits are subject to Long Term Capital Gains taxes which is typically a much lower rate.
2. Property Management and Travel Deductions
You are entitled to deduct most expenses for managing the property, from mortgage interest to office supplies. If you have a home office, you may be able to deduct expenses such as your cell phone, internet costs, mortgage interest and more. Your accountant can tell you if the office in your home qualifies as a true home office. Another common deduction is the standard mileage deduction. According to the IRS, in 2018 the standard mileage rate is 54.5 cents per mile for business travel. You can apply this rate when you visit your rental properties. You may be able to deduct meals and other travel expenses associated with the trip.
You are entitled to a depreciation deduction based on the idea that materials break down over time. You can deduct a portion of a real estate building, not the land, each year. For residential real estate, depreciation is based on a 27.5 lifespan. For commercial real estate, it is 39 years. Be aware that when you sell the property you pay a “recapture of depreciation” tax, currently 25%, on the profit you make. Keep in mind that you may have taken more than that in tax deductions over the years, in which case you have the advantage. You also had the use of the money (the time value of money) to invest as you saw fit.
4. Avoid the Recapture of Depreciation Tax
You can avoid the Recapture of Depreciation Tax by using the 1031 Exchange. This is the IRS tax code that allows you to sell your property and buy another property using the profit in order to defer taxes. So if you bought a property several years ago and sold it today, you would owe your capital gains tax on the profit plus the Recapture of Depreciation tax. However, if you choose the 1031 Exchange option by using the profit as a down payment on another “like kind” property, you don’t pay the Recapture of Depreciation tax. There is a strict time limit of 180 days for closing on the new property, and you must place the profit from the former property in the hands of an intermediary while the deal is pending. If you keep a portion of the profit you are be liable for taxes on that portion.
5. No FICA or Self-Employment Tax
Rental property investment income is not taxed as “earned income.” Most Americans pay either FICA (Federal Insurance Contributions Act) taxes or Self-Employment Tax, two taxes that help to fund Medicare and Social Security. In the case of FICA, the 15.3% tax is shared by both the employer and the employee. The self-employed are responsible for the total 15.3%. As a real estate investor, you may not be required to pay this tax.
Tips for Reaping Tax Benefits on Real Estate
The best tip for saving money on taxes is to speak to a accountant to find out how tax laws affect your business. Contacting a professional is especially critical now that extensive tax changes are taking effect. Real estate investing can have enormous tax advantages, but you have to follow the rules to avoid penalties.