Tax Benefits of Investing in Real Estate | Think Realty | A Real Estate of Mind
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Tax Benefits of Investing in Real Estate

Real estate investment is one of the most lucrative investment options available. The industry has created countless millionaires since time immemorial. In fact, many financial experts rank real estate as the best investment to get the highest return on investment (ROI). This is also backed by many studies that have proven real estate provides higher profits compared to bonds, stocks, or other investment strategies.

Did you know that by investing in real estate you also set yourself up for massive tax benefits? Some of them involve paying lower tax rates, and in other cases, you pay no tax at all.

Why does the government provide tax benefits for real estate investors? They do this to make the economy enticing for stimulation. The government understands that by creating tax loopholes for people to create wealth, they’ll be more productive to get wealthy and also benefit those around them.

Here are some compelling tax benefits you stand to enjoy by investing in real estate either actively or passively.

Deductions

One of the massive tax benefits to be enjoyed by real estate investors comes in the form of deductions. As a real estate investor, you can deduct specific expenses associated with the investment property, such as property tax, mortgage interest, property insurance, and property management fees. You can deduct the expenses associated with property repairs and maintenance.

You can also deduct the costs that are involved with managing and conserving the property to stay in top-notch condition. This means you can write off expenses such as repairs that don’t add value to the property but keep it in good condition.

An investor can also deduct a mortgage on the primary or secondary residence. You can apply this to home purchases or home equity loans

Make sure you leverage these deductions well. Sometimes the benefits are not associated with real estate. For example, if you itemize it using your home office, you can deduct a percentage of work-related expenses such as phone bills or Internet fees.

Depreciation

Depreciation is another massive benefit of investing in real estate. Primarily, if you own income-generating property, such as rental units, you can recover the cost through annual tax deductions.

Depreciation is defined as deducting a property’s loss in value over its expected “shelf life”. The lifespan of residential property is set at 27.5 years while that of commercial property is 39 years. In simpler terms, it’s an allowance given for wear and tear.

The amount of depreciation you’re allowed to deduct is determined by the value of your property, its recovery period and the depreciation method applied.

Let’s look at a practical example. Say you bought a rental property for $250,000. This makes you entitled to an annual depreciation deduction of $9,090 ($250,000 / 27.5 years). In addition, you can also depreciate particular capital expenses, such as roof or HVAC system replacement after a certain period. This can add the total amount of depreciation to your annual tax deductions.

Note that property depreciation tax deductions don’t last forever. You’ll have to reclaim the depreciation value when selling your property and pay taxes for it too. This is perhaps a strategy to make sure real estate investors keep their property for a long time.

Capital Gains

Capital gains refer to the profits that investors make when they sell their property, whether residential, commercial, or industrial property. Capital gains offer a lower tax rate compared to ordinary income tax. There are basically two ways how this is taxed:

  • Short-term: This refers to gains on property held under one year. There are no special tax benefits derived from short-term gains as it can range from 10% to 37% based on your income bracket.
  • Long-term: These are gains derived from property that was held for longer than one year. This is mainly associated with rental properties and offers a much lower tax rate compared to short-term gains.

As an investor, you should make sure you leverage on long-term capital gains. As mentioned, you’ll have a lower tax rate and you can make use of deductions gained over the property-ownership period to lower the taxable amount.

1031 Exchanges

The 1031 Section of the IRS allows real estate investors to sell their property and use the profits to purchase another property of equal or greater value. This means that you can postpone paying taxes until you’ve sold the next property. You can also choose to go for another 1031 swap.

In layman’s terms, this tax benefit allows investors to roll over paying tax while gaining from one investment to another until you sell it one year later.

To qualify for a 1031 swap, the next property must be equal to or greater than the current property in value. In addition, the current property has to be exchanged for another asset, such as land or another house. This rule doesn’t apply to furniture, appliances, or any other thing you may wish to spend money on. Also, the property has to be held productively, either for business or trade.

Bottom Line

If these tax benefits sound great to you, you should consider getting into real estate investment. This gives you the potential to make massive profits while also enjoying great tax benefits.