Tax Advantages of Real Estate

Real Estate provides many benefits over traditional investment vehicles. The greatest benefit above all, in my opinion, is the tax advantages. These advantages come in the form of depreciation, tax-free cash flow, and the 1031 exchange.

Depreciation

• Investing in real estate provides you with the opportunity to recognize a loss on your taxes to offset other income, all while the tenants in your property pay down your mortgage and you collect tax-free cash flow. This loss comes about as a result of a major expense item: depreciation. Not only can you depreciate the building, but you can also depreciate many items within the building, such as furniture, fixtures, and other equipment.

Tax-Free Cash Flow

• As an investor in real estate, when you receive a cash distribution, it is treated as a return of investment until the full amount of principal has been returned to you, and you therefore do not have to pay tax on these distributions. This is also true in the case of a refinance; so long as the principal has not been completely returned, you do not recognize a distribution that results from a refinance as taxable income. When will you have to pay tax? See below for that answer.

1031 Exchange

• Normally, upon sale of your property, you will have to pay taxes on any capital gain. The 1031 exchange, however, is your opportunity to defer payment of taxes indefinitely into the future. This allows you to sell your property, use the sales proceeds to invest directly into another property within a six month time frame, and defer paying taxes on any capital gain into the distant future, or, depending on whether you continue this practice forever, never. This is where you see that real estate can be a very powerful tool, and by the power of compounding, you can grow your wealth much faster than by paying taxes.

So there you have it. Real estate can be a powerful investment tool in your investment toolbox, providing you with multiple tax advantages that cannot be found in other traditional investment vehicles.