The holy grail of investing in real estate is that you get far more tax deductions than an average side hustler does. The trick, however, lies in identifying what's available and what's not and capitalizing on it.
There are plenty of ways to maximize your tax deductions as a real estate investor, but choosing the right and the best strategies requires research, knowledge, and professional guidance. Let’s look at some of the ways you will be able to deduct the tax.
Interest deductions provide the most effective way of reducing taxes, depending on the method used to finance your real estate. These deductions can include interest paid on mortgages, loans, credit lines, and other sources. It is important to note that only the portion of interest paid can be deducted, not the principal payment. For instance, if your monthly mortgage payment is $5,000, with $4,000 allocated towards the principal and $1,000 towards interest, the $1,000 interest payment over the course of the year amounts to $12,000 in tax-deductible expenses.
Pass-through deductions are a temporary deduction facility provided under the Tax Cuts and Jobs Act, applicable to individuals who report income on their personal tax returns. This deduction allows for a 20% reduction in taxable business income. The deduction took effect in 2018 and is set to expire in 2026. It applies in a straight forward manner to income up to $157,500 for individuals or $315,000 for joint filers.
Depreciation refers to the gradual deterioration of a property over time, and it is commonly treated as an annual expense. Real estate owners have two methods of depreciation available to them. The first pertains to assets, where residential properties or assets are typically depreciated over a period of 27.5 years, while certain commercial properties recognized by the IRS undergo depreciation over 15 years. The second type of depreciation concerns improvements or updates made to the property. The IRS distinguishes between maintenance and improvement by considering an improvement as something that enhances, restores, or adapts the assets. Depreciation serves as a paper expense that allows you to maximize your deductions. However, it is important to note that you are required to pay taxes on all profits you had previously avoided through "depreciation recapture." When faced with such scenarios, seeking the guidance of an experienced tax planner can help you develop effective strategies.
The property tax deduction can be claimed for both private property and any rental property you own. However, property taxes can often be high in urban areas, and they are eligible for deduction. It is important to note that if you purchase a property and agree to pay outstanding property taxes, those taxes will be included in the overall cost of the property and cannot be deducted separately. By preparing your property taxes diligently, you may be able to claim property tax deductions on time.
Additionally, if you invested in a property this year, you may have already paid the deductible taxes in your original property paperwork, even if you receive the bill later in the year. This separate tax bill is merely an adjustment, not a final amount. Therefore, make sure to include all the taxes you have paid to maximize your deductions.
The 1031 Exchange, alternatively referred to as a like-kind exchange or a Starker exchange, enables real estate investors to sell a property and reinvest the proceeds into a new property without incurring taxes on the capital gains from the sale. To qualify for a 1031 exchange, there are several rules that must be adhered to, including:
These are the rules that must be followed when completing a 1031 exchange. If planned carefully, this option can offer significant advantages for expanding your business.
The Federal Insurance Contribution Act (FICA) is a tax deduction of 15.3 percent applied to income tax. In the case of an employee-employer relationship, this tax is divided equally between both parties, with a 50/50 split. However, as a self-employed individual, you are entitled to the full tax benefit of the entire percentage. It is worth noting that this tax deduction can be offset based on the legal structure of your real estate business.
Opportunity Zones represent a United States government program carefully crafted to adopt economic development and stimulate investment within specifically designated low-income communities and areas. Originally established in 2018 as a tax incentive under the Tax Cuts and Jobs Act, this initiative offers enticing benefits to investors who choose to allocate their capital gains into Qualified Opportunity Funds (QOFs), thereby supporting projects within the opportunity zones.
There are several strategies that real estate investors can employ to maximize their tax deductions. However, it is essential to conduct thorough research, seek professional guidance, and stay updated on tax laws and regulations to ensure compliance and make informed decisions. By employing tax strategies effectively, real estate investors can potentially reduce their tax liabilities and optimize their financial returns.
Our team at Investor Friendly CPA® consists of experts and professionals that can provide you with knowledge and professional guidance to assist you inefficiently planning your tax deduction. We would be happy to provide you with consultation to ensure that you are able to save the most in tax and take advantage of opportunities to minimize your tax liability.
Investor Friendly CPA is devoted to serving the real estate industry. We provide proactive solutions to the accounting needs of investors, developers, contractors, and other industry constituents
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