Real estate investment offers wealth-building potential, yet it entails significant tax responsibilities. For investors, grasping tax liability is vital for a successful business strategy. An effective tax approach can optimize profits, minimize losses, and simplify the tax filing process.

KEY TAKEAWAYS:

• You can optimize tax with a 15% capital gains rate by holding properties for over a year and avoid double FICA taxes through legal entities by refraining from routine property selling.

• One can also maximize tax efficiency by collaborating with professionals to cherry-pick accurate and paper deductions.

• By meeting the Qualified Business Income benchmarks, you can unlock the 20% pass-through deduction for small businesses.

• IRA Wisdom: Explore the tax benefits of Self-Directed IRAs (Individual Retirement Accounts) for real estate investments, adhering to IRS (Internal Revenue Service) guidelines.

In this article, we will explore some key strategies that real estate investors can use to optimize their tax liabilities and achieve their financial goals. Whether you are a seasoned investor or just starting, there is always something new to learn when it comes to taxes and real estate.

TAX SAVING STRATEGIES FOR REAL ESTATE INVESTORS

1. Holding Properties for More Than a Year

Selling your property within a year subjects your profit to your regular income tax rate, classifying you as a real estate flipper. This categorization as a self-employed dealer by the IRS triggers double FICA taxes. To mitigate this, holding the property for over a year qualifies you for a 15% capital gains rate, lower than standard income tax rates.

2. Avoid Paying Double FICA Taxes

Selling your property within a year means your profit is taxed at your regular income tax rate, labeling you as a real estate flipper and subjecting you to double FICA taxes as a self-employed dealer. Holding the property for over a year qualifies you for a lower 15% capital gains rate, a significant reduction compared to standard income tax rates.

3. Maximize Your Deductions

Real estate investors have the benefit of deducting every real expense and some paper expenses for tax purposes. You can view the list of items that IRS provide in Schedule E or Schedule C to reduce the amount of total taxable income. We suggest you speak with a professional accountant to discuss your tax bill.

4. 20% Pass-Through Deduction

The Tax Cuts and Jobs Act of 2017 has included a tax advantage for small business owners which also includes real estate investors. This rule allows small business owners to deduct an extra 20% of their net business income. To be eligible for the pass-through deduction, the business must generate QBI (Qualified Business Income), which is the net income from the business. However, there are certain limitations and exclusions that may apply, depending on the type of business and the taxpayer's income level.

5. Own Properties in a Self-Directed IRA

A Self-Directed Individual Retirement Account (IRA) expands investment options beyond traditional assets, offering advantages like tax deferral, diversification, and potential rental income. However, strict adherence to IRS guidelines is crucial. Key considerations for real estate investment via a self-directed IRA include:  

• Investment Purpose: The property must be solely for investment, not personal use, and it must encompass rental, commercial, or raw land.

• Custodian Management: Investments should be held by a specialized custodian responsible for managing them on behalf of the owner.

• Expense Coverage: All investment-related expenses, including repairs, must be funded from the self-directed IRA.

• Income Reinvestment: Rental income or profits from the investment sale must be reinvested back into the IRA.

FAMOUS TAX LOOPHOLE FOR REAL ESTATE OWNERS

Real estate owners commonly employ depreciation as a tax strategy, allowing an annual deduction from their property cost, reducing taxable income and overall tax liability.

A 1031 exchange is another strategy, enabling property owners to defer capital gains taxes by reinvesting in similar property within a specified period, postponing tax payments until the eventual sale of the new property.  

Qualifying as a real estate professional does not require a license. The IRS considers two criteria for qualification:

1. Material participation in providing personal services in real estate for more than half the time of all personal services provided for the year by the taxpayer.

2. Material participation for over 750 hours during the tax year in providing personal services in real property trades or businesses.

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CONCLUSION

It is important to note that all the strategies you employ must be in compliance with IRS rules and regulations. We suggest that you consult with a qualified tax professional to determine which strategies are appropriate for your situation or business and to ensure that you are following all applicable tax laws.

Investor Friendly CPA® can help you in tax planning and develop tax saving strategies specific to your business. We have a team of professionals that are always ready to provide guidance to you to ensure that you have the best strategies for your business.

Reach out to our team by completing the new client form on our website with no obligation.  

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