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Updated over 1 year ago, 10/08/2023
Tax Saving Strategies in Real Estate Investing
As an experienced real estate-oriented CPA with clients that invest in most real estate markets, I often get asked for strategies in saving money on taxes that apply to clients investing activities. Here are some key tax saving strategies summed up:
- 1) Cost Segregation Studies: A cost segregation study is a powerful tool that can accelerate depreciation deductions, resulting in significant tax savings. While traditional depreciation schedules span 27.5 years for residential properties and 39 years for commercial properties, a cost segregation study identifies and reclassifies certain components of the property as shorter-lived assets. This can include items like lighting, flooring, and even landscaping. By doing so, investors can front-load depreciation deductions, providing substantial tax benefits in the early years of property ownership.
- 2) Conservation Easements: Conservation easements involve donating development rights or restrictions on a property to a qualified charitable organization or land trust. While this strategy primarily aims at preserving environmentally sensitive land, it can also offer substantial tax incentives to real estate investors. Investors who donate a conservation easement may be eligible for federal tax deductions and potentially state-level incentives, effectively reducing their taxable income.
- 3) Opportunity Zones: Opportunity Zones are designated economically distressed areas where real estate investors can invest capital gains and receive substantial tax benefits. By investing in these zones, investors can defer and potentially reduce their capital gains tax liability. Additionally, if the investment is held for a certain period, some or all of the gains may become tax-free. While Opportunity Zones are becoming more well-known, they still offer unique tax advantages that many investors might not fully understand.
- 4) Real Estate Professional Status: To qualify as a real estate professional for tax purposes, an investor must spend more than 50% of their working hours and over 750 hours each year materially participating in real estate activities. If you meet these criteria, you can potentially deduct real estate losses against other forms of income without the usual passive activity loss limitations. This can be a powerful way to offset taxable income.
- 5) Self-Directed IRAs and 401(k)s: While not entirely unknown, self-directed retirement accounts are still underutilized by many real estate investors. These accounts allow individuals to invest in a wide range of alternative assets, including real estate. Contributions to traditional self-directed IRAs are tax-deductible, and any gains generated within the account can grow tax-deferred or even tax-free in the case of a Roth self-directed IRA. This can be particularly advantageous for those looking to invest in real estate within a tax-advantaged retirement account.