Tax Benefits of Real Estate

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Have you ever wondered how millionaire and billionaire real estate investors can claim that they pay no or low-income taxes on the tax return every year?

This time we're going to go over the tax advantages of investing in real estate and how you can make it work for you.

As a disclaimer, I am not giving you tax advice. I'm not a CPA, I'm not an accountant. So, I would highly recommend consulting with your accountant before taking any positions.

Generally, as a homeowner, there are tax advantages to owning a home. You can write off the interest that you pay on your mortgage up to a certain amount, and you can also write off the real estate taxes as well.

And, when it’s time to sell your home, you're able to exclude up to $500,000 of any gains on the property if you have lived there for at least two years in the last five years of it being your primary residence. If you're single or head of household, I believe you can get an exclusion of about $250,000, and if you’re married filing jointly, you're able to exclude any gains on the property for up to $500,000.

Moreover, in real estate investing, one of the big tax advantages is depreciation. Even though your property is going up in value, the IRS explains that the structure itself is breaking down and actually going down in value.

To reflect that, the IRS allows you to write off the cost of the house over a certain amount of time, but not the land portion. You will have to take the land portion out. Discuss with your CPA about how much you should allocate to land, and to real estate. You're allowed to depreciate it over 27 and a half years for residential real estate, while for commercial, I believe it's 39 years.

If you want to get a little more aggressive, you can do something called Cost Segregation. Earlier, I’ve mentioned about being about to separate the cost of the real estate to land and the property itself. The property itself can actually be broken up to real property and personal property.

Personal property is stuff like the appliances, the carpet, and so on. You can hire a company to do a cost segregation analysis, and break part of real estate costs into personal property.

Personal property has a more accelerated depreciation and can depreciate over a five-year life, a seven-year life, or 15-year life. This is to your advantage because you get a bigger chunk of the depreciation earlier.

Furthermore, in real estate investing, the depreciation will cover the income that you're generating from the property, so you don't have to pay taxes on the income from the rental property. And take it a step further, most of the time you're able to create losses and use it to your advantage.

In certain situations, you're able to take the losses that you generate from real estate and offset them against other forms of income, specifically your W2 job. Let's say you're able to generate $10,000 in real estate losses, and you make $100,000 at your W2 job. You're able to take the $10,000 in losses and offset it against your $100,000 of income that you're making from your job. You will not be taxed on the $100,000 but only for $90,000.

Obviously, there are limitations. I think it starts at a $100,000 adjusted gross income, and it's completely phased out once you've hit a 150,000. But there's actually one way around it if you're a real estate professional.

You can write off all your losses against your active income. The reason being is if you're a real estate professional, it is no longer passive, it's all active income to you. So, you're allowed to offset the same type of income. Active income can be offset against active income and active losses.

Say you are married to a real estate professional, and filing your taxes jointly, both of you are considered real estate professionals. Therefore both your losses can offset the active income.

Additionally, when you sell your properties most of the time, they're going to be capital gains instead of ordinary gains that are taxed at ordinary rates. Capital gains benefit from lower rates. So depending on what your tax bracket is, your capital gains tax could be 0%, 15%, or 20%.

They're much more favorable than the normal tax bracket if you don’t usually sell your properties.

The next tax benefit of real estate investing is something called the 1031 like-kind exchange, which a lot of investors use when they sell a property. How does it work?

As long as you sell your property and invest the proceeds in another investment property, then you don't have to pay capital gains for that sale. You can delay the payment of capital gains into the future, even in perpetuity.

Say, you keep doing the 1031 exchange, and you pass away, your heirs will inherit the advantage and avoid paying taxes on the appreciation.

Finally, the last tax advantage that comes to mind is that real estate investing is a business. This refers to you being able to write off business expenses.

Do you need a cell phone to make calls to find deals? Yes, that can be written off.

Do you need a car to drive around to look at houses? Yeah, that can be written off.

Do you need a new MacBook to analyze deals? Yes. These are all business expenses that can be written off.

Some of these strategies can be tricky. I would really encourage you to consult with your CPA because doing any of it, as you may get audited if done carelessly. But when done just right, these tax benefits may or may not get your tax bill down to zero, but they will definitely help you preserve your wealth and help you grow your wealth.