3 Tax Tips for Real Estate Investors

8

On April 15th every year, we  Americans give a portion of our hard earned money to the government.  As real estate investors, we are presented with unique opportunities to lessen the impact taxes can have on the bottom line. However, in order to take full advantage of any tax benefits, it’s important that investors put themselves in the best position possible to do this.

Here are three important tips to put investors on the right path:

Download Your FREE guide to evicting a tenant!

We hope you never have to evict a tenant, but know it’s always wise to prepare for the worst. Navigating the legal and financial considerations of an eviction can be tricky, even for the most experienced landlords. Lucky for you, the experts at BiggerPockets have put together a FREE Guide to Evicting Tenants so you can protect your property and investments.

Click Here For Your Guide to Evicting Tenants

1.) Get Organized

This advice is applicable anywhere, but pertains especially to taxes. It can be hard to hear, but there are no excuses for having an unorganized business. Organization is an essential skill for any business owner, but especially real estate investors.

From keeping detailed records and receipts to managing expenses, staying organized is critical when tax season rolls around. For those investors that have the ability and the time, self-managing the bookkeeping may be a viable option. There are a handful of very good accounting programs out there that can help in this area.

I actually kept my own books for the first two years I was in business, but quickly learned that it made more sense to contract this out to a good bookkeeper. Most investors learn early on that their time is better spent managing the business rather than buried in the tedium of bookkeeping. Either way, it’s crucial that you have a system in place to record and archive all aspects of the business.

Hire A Good CPA

A good Certified Public Accountant is worth his or her weight in gold. Navigating tax law in order to maximize your profits can be a very daunting task. An experienced CPA, however, will be able to guide you in structuring your business, as well as maximizing your deductions without crossing any legal boundaries. Keep in mind that having your business organized will help your CPA do his job that much more effectively and efficiently.

Use Real Estate Investments to Your Advantage

There are several ways tax law is set up to benefit investing, and particularly real estate. Rental properties are fantastic in this regard, as you get to depreciate the structure of the property over the next 27.5 years. This depreciation can be a great way to offset any cash flow income the property may be generating. At the same time, the real estate is likely appreciating in value without incurring any additional tax liability as a result. Once you decide to sell the property, any income earned as a result of appreciation is treated as capital gains as opposed to income tax (which is typically much higher). Typically, selling property that you have owned for more than a year can fall into this category.

And of course investors have the ability to capitalize on another tax savings known as a 1031 exchange.  A 1031 enables investors to defer the capital gains tax by moving profits from the sale of one property directly into the purchase of a new property. By continually deferring tax liability from the sale of properties, many investors have amassed real estate fortunes without ever having paid taxes on the gains from those properties.

Again, I cannot stress enough the importance of partnering with a knowledgeable CPA who has a good understanding of real estate. A good CPA can help formulate tax saving strategies that will put you on the road to prosperity. While most people consider taxes a necessary and unpleasant annoyance to be dealt with once a year, the savvy real estate investor will use the tax laws to not only save money, but earn more in the long run.

About Author

Ken Corsini

Ken Corsini G+ is the host of the Deal Farm Podcast (on iTunes) and has 10 years of full-time real estate investing experience. His company, Georgia Residential Partners buys and sells an average of 100 deals per year and has helped hundreds of investors around the country make great investments in the Atlanta market. Ken has a business degree from the University of Georgia and a Master Degree in Building Construction from Georgia Tech. He currently resides in Woodstock, Georgia with his wife and 3 children.

8 Comments

  1. Good points but I think you might modify your statement “A 1031 enables investors to defer the capital gains tax by moving profits from the sale of one property directly into the purchase of a new property.” and use the word “Property(ies)” or “Properties”. Why, because you can 1031 Exchange from “One property” into multiple properties and conversely you can 1031 Exchange from multiple properties into one property.

    Case in point, you can 1031 Exchange four SFRs into a multi-unit like an apartment house. And you can 1031 Exchange one SFR into two Condos etc.

  2. All great points. I have a few thoughts to add.

    1) Depreciation recapture is 25%, unlike the typical capital gains rate of 15%. The depreciation recapture unfortunately applies even if the person forgot to take the depreciation deductions each year. For a person who was in the 15% tax bracket for many years while taking in rental income, they are actually being taxed at a higher rate than if they had never been required to take depreciation deductions and then pay them back at the higher 25% rate. Perhaps real estate investors should lobby to make depreciation deductions – and the associated recapture – optional.

    2) The 1031 exchange allows them to defer paying capital gains and depreciation recapture. For most people, capital gains rates are fairly low right now, but might be higher in the future. Therefore, there might be situations where the person is better off paying taxes on their capital gain upon a sale now, rather than paying at possibly higher rates in the future. In theory, they could keep rolling those gains over indefinitely and never face capital gains tax – as long as they don’t mind having that equity locked up in real estate.

    • Matthew:

      To clarify further… Depreciation recapture is taxed at a MAXIMUM of 25%. The amount of depreciation recapture is taxed as ordinary income – so it is taxed at whatever bracket you happen to fall into in the year of the sale. If you’ve taken the deduction while in the 15% bracket, and then you sale while still in the 15% bracket, you basically break even. If the recapture amount is big enough, it can push you into a higher marginal bracket – which would match the scenario you described when depreciation results in higher taxes. If someone is in the 39% bracket, however, they get depreciation expense at 39%, and recapture at a max of 25%… which is a pretty good deal.

      The strategy with the absolute best tax savings is using rental real estate as a retirement plan and inheritance gift to your heirs. You accumulate rental real estate throughout your life, and do 1031 exchanges the entire time. When you retire, you’ve got some nice passive income for your living expenses. When you die, all the property that your heirs inherit gets a step-up in basis to the fair market value at the time of your death. They can sell it the next day and pay zero tax. That is permanent, tax-free income!

  3. Shane,

    Very good points, especially about the stepped-up basis upon death. That’s one topic that often gets ignored in the mainstream media.

    As far as depreciation recapture, it would seem fairly common for the lump sum of income from a property sale to push a person into the next income bracket, especially if a person bought the properties many years ago and suddenly has alot of phantom income. Also, the tax code is somewhat ambiguous on whether the recapture is 25%, or the ordinary rate up to 25%. Your interpretation is the logical one, but logic does not always prevail over technicalities in the tax code.

    The bracket limit for the 15% bracket is just over $70k for a married couple. Accounting for deductions that means pre-tax income of $80k. So there may be some landlords in the 15% bracket most years, who would be pushed into the 25% bracket in years when they sold a property.

    Some advisers even tell homeowners not to take home-office deductions due to depreciation recapture, although I find that advice surprising.

    Thanks for your comment.

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here

css.php