7 Tax Benefits of Real Estate Investing

Mon, 03 Oct 2022 13:05:14 -0500

You know that diversifying your investments is a smart move. Plus, you’ve heard that buying rental properties can produce a valuable, recurring cash flow from a mostly passive income. But are you aware that it can also make your financial picture rosier come tax time?

Read on to learn about the many tax benefits of real estate investing and how you can maximize savings on your yearly return.

1. Use Real Estate Tax Write-Offs

One of the biggest financial perks of this income stream is the real estate investment tax deductions you’re able to take. You get to deduct expenses directly tied to the operation, management and maintenance of the property, such as:

Property taxes
Property insurance
Mortgage interest
Property management fees
Cost to maintain and repair the building

But did you know that you can also write off much of what you pay to run your real estate investment business? Qualified business expenses may include, but aren’t limited to:

Advertising
Office space
Business equipment (e.g., computer, stationery, business cards, etc.)
Legal and accounting fees
Travel

All of these deductions lessen your taxable income, which could save you money when you pay taxes. Let’s say your rental income is $25,000, and your related, qualified expenses come to $8,000. That means the taxable income from your real estate business is $17,000.

Pro tip: Be sure to keep detailed, accurate records and receipts so you can prove the expenses you claimed in case you’re audited by the Internal Revenue Service (IRS).

2. Depreciate Costs Over Time

Depreciation is the incremental loss of an asset’s value, generally due to assumed wear and tear. As a real estate investor that holds income-producing rental property, you can deduct depreciation as an expense on your taxes. That means you’ll lower your taxable income and possibly reduce your tax liability.

You’re allowed to take the depreciation deduction for the entire expected life of a property (currently set by the IRS as 27.5 years for residential properties and 39 years for commercial properties).

For instance, maybe you purchase a home you intend to rent out. The value of the building itself (excluding the land it sits on) is $300,000. If you divide that value by the 27.5 year expected life of the dwelling, you can deduct $10,909 in depreciation each year.

Once you sell, though, be prepared to pay the standard income tax rate on the depreciation you’ve claimed. This requirement is known as depreciation recapture, which you can avoid if you pursue other tax strategies, like a 1031 exchange (more on that below).

Pro tip: Ask your accountant about depreciating major improvements you’ve made to your investment properties, such as installing a new roof.

3. Use A Pass-Through Deduction

A pass-through deduction allows you to deduct up to 20% of your qualified business income (QBI) on your personal taxes. When you own rental property as a sole proprietor, via a partnership, or through an LLC or S Corp (known as pass-through entities), the money you collect in rent is considered QBI by real estate tax law.

For example, if you have an LLC that owns an apartment complex, you could receive $30,000 in rental income every year. By using a pass-through deduction, you can write off up to $6,000 on your personal return. Of course, some rules and regulations must be followed, so please consult with your accountant.

Please note: This perk, along with other provisions in the Tax Cut and Jobs Act of 2017, is currently set to expire in 2025.

4. Take Advantage Of Capital Gains

A capital gains tax may be assessed when you sell an asset, like a piece of property, for a profit. There are two types to be aware of: short-term and long-term. They each impact your tax situation differently.

Short-Term Capital Gains

When you profit from selling an asset within a year of owning it, you realize a short-term capital gain. While you may not have a choice but to sell, be aware that doing so can have a negative effect on your taxes. That’s because the gain gets counted as ordinary income.

So, if you earn $100,000 from your day job and sell an investment property for a $100,000 profit, your income essentially doubles for tax purposes. If you file single, that extra income puts you in the next tax bracket (as of 2020), which potentially means a larger tax bill than you expected.

Long-Term Capital Gains

On the other hand, you see a long-term capital gain if you profit from the sale of an asset that you’ve held for a year or longer. If you can wait until the anniversary of your purchase to sell, you’ll get to keep more money in your pocket. That’s because long-term capital gains have a significantly lower tax rate than your standard income.

And, if your income is low enough, you may not have to pay the tax at all. Suppose you and your spouse make a combined $75,000 per year and file a joint tax return. The long-term capital gains are tax-free since the tax rate for your income level is 0%. That means you can keep every cent of the profit you get when selling a property.

5. 1031 Exchange

1031 exchanges exist because the government wants to reward people who reinvest their real estate profits into new deals. As long as the new property you buy is of equal or greater value than the one you sell, the program lets you swap them for tax purposes. That means you can defer paying the capital gains tax on the sale of the first property.

You can use 1031 exchanges indefinitely. But, when you want to cash out your profits, you’ll have to pay any tax owed. There are a few different forms of the program available based on the timing of your purchase and sale transactions. Since the program can be complicated to navigate and take full advantage of, it’s wise to consult with a qualified financial professional.

6. Opportunity Zones

Designated by the US Department of Treasury, opportunity zones are low-income or disadvantaged tracts of land. The 2017 Tax Cuts and Jobs Act encourages investors to put their money into developing and economically stimulating these communities by offering tax breaks.

Alongside other real estate investors, you place your unrealized capital gains into a Qualified Opportunity Fund. Money from that fund goes toward improving the selected area.

If you play by the rules of the program, you can enjoy the following tax advantages:

Defer paying capital gains until 2026 (or until you sell your stake in the fund).
Grow your capital gains by 10% if you hold the fund for 5 years; 15% for 7 years.
Avoid paying capital gains entirely if you remain invested in the fund for 10+ years.

7. Business Tax Benefits

When you’re self-employed, you generally need to pay both the employer and employee portion of the FICA tax (covering Social Security and Medicare). However, if you own rental property, the money you receive isn’t classified as earned income. That means you’re eligible for one of the least talked about real estate tax breaks: avoiding the FICA tax, also known as the payroll tax.

Here’s the math in action:

Let’s pretend you own a freelance writing business that generates $50,000 in revenue. Since that money is considered earned income, you’re on the hook for the payroll tax. At a 15.3% tax rate, you’d have to fork over $7,650. But, if you’re a rental property owner instead, you would get to keep that cash in the bank.

Take Advantage of Your Tax Benefits

There are a lot reasons to invest in real estate, and tax benefits are just one. If you're considering real estate as an investment, get preapproved first. This will help you be prepared to make a great purchase.

Get started with a Gapital pro.

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Frequently Asked Questions about the Loan Process

Mon, 24 Jan 2022 13:19:33 -0600

Am I committing to Gapital by getting pre-approved?

No. Our mortgage preapproval is meant to make your home-shopping experience easy and seamless and allow you to understand the types of mortgage loans and rates available to you. Completing the preapproval mortgage application does not mean that youâ€™re required to continue with Gapital.

Will I have a point of contact at Gapital?

Yes. As soon as you complete your initial preapproval process, we'll introduce you to your mortgage loan originator. You can contact your loan originator anytime throughout the process.

How quickly can I close my loan?

Gapital usually closes mortgage loans within four weeks of disclosing a loan. The exact timing depends on a few factors, including how quickly you can submit all required documents, as well as the timing of third-party services. The most common situation that requires a longer time is when a seller has made the closing contingent on closing on their new home. If your mortgage loan happens to have more complicated circumstances and will take longer to close, your mortgage loan originator will discuss this with you when it's time to lock your rate, and you may agree to a longer lock period.

Do I need to have an escrow account?

An escrow account is not required for most borrowers. However, having an escrow account usually helps in getting the best mortgage rate and maintaining your peace of mind.

If you choose to have an escrow account:

The annual amount of your property taxes and homeowners insurance will be divided by 12.
Your monthly mortgage payment will be increased by the monthly amount of your taxes and insurance.
Your mortgage provider will pay your taxes and insurance for you out of the escrow account.
Your total mortgage payments are the same, and you may get a better rate.

Without an escrow account, you are responsible for paying your tax and insurance bills directly.

Can I transfer my current escrow account?

No. Any balance in your current escrow account at the time of new mortgage loan funding will be refunded to you by your current mortgage servicer. This typically happens within three weeks from time of closing.

What do I need to do to lock my rate?

After you get preapproved and find a property, we will present you with the day's current mortgage rate options. At that time, you can request your loan originator to lock your rate. Your loan originator will help guide you through the decision if you're not sure.

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