What Are the Important Tax Benefits of Investing in Real Estate?

Investing in real estate isn’t just about achieving financial freedom. It’s also about getting big tax breaks! Let’s look at some of the ways owning property can lower your tax bill.

Deductible expenses

Real estate investors can deduct many expenses related to their rental properties. These deductions are subtracted from your rental income, lowering your taxable income. Some common deductible expenses include: Property taxes, Property insurance, Property management fees, and Repair and maintenance costs

You can also deduct certain business expenses, such as: Advertising costs, Office space rent, Business equipment (computer, printer, etc.), Accounting and legal fees, and Travel expenses.

Depreciation

Imagine deducting the entire purchase price of your rental property from your taxes! While not exactly possible, depreciation comes close.

Depreciation reflects the gradual decrease in a property’s value due to wear and tear. The IRS allows real estate investors to deduct depreciation on their rental buildings over 27.5 years.

Think of it as spreading the tax deduction for the building’s cost over many years.

Passive Income and Pass-Through Deduction

Passive income comes from businesses where you’re not actively involved. Rental income from investment properties is a common example. Before 2018, rental property investors could only offset passive income with passive losses. However, the Tax Cuts and Jobs Act of 2017 introduced the qualified business income (QBI) deduction, also known as the pass-through deduction.

This deduction allows real estate investors, along with small business owners and self-employed individuals, to deduct up to 20% of their income from qualified sources like rental income. This can significantly reduce your tax bill.

Capital gains tax

When you sell a property that has increased in value, you may owe capital gains tax on the profit. This applies to various property types, including single-family homes, apartments, and condominiums.

The capital gains tax rate depends on your income, how long you’ve owned the property, and your tax filing status. Rates can range from 0% to 20%, with lower rates for long-term ownership (more than one year).

So, if you’re thinking about investing in real estate, keep in mind the tax benefits on top of the potential rental income and property value growth.

Tax Considerations by Property Type:

While the deductions and depreciation apply to all properties, there can be nuances depending on the type:

• Multi-Family Properties: With multi-family buildings (duplexes, apartments), you can only deduct a portion of expenses and depreciation based on the percentage of the property you rent out. For example, if you live in one unit of a duplex and rent out the other, you can only deduct half of the property’s expenses and depreciation.
• Single-Family Homes: These qualify for the primary residence capital gains tax exemption if you meet the ownership and usage requirements.
• Self-Storage Facilities: These may have different depreciation schedules and potential tax benefits specific to commercial real estate.

Remember:

State and local tax laws can also impact your real estate investment. Consulting a tax professional for personalized advice is crucial.

Primary Residence Exclusion:

If the property was your primary residence, you may qualify for an exclusion from capital gains tax under the following conditions:

• Ownership and Use Test: You must have owned the home for at least 2 of the last 5 years before the sale and lived in it as your primary residence for at least 2 of those 5 years.
• Exclusion Amount: If you meet the ownership and use test, you can exclude up to $250,000 of capital gains if you are single, and up to $500,000 if you are married filing jointly.

Conclusion

Tax breaks significantly impact real estate investors’ overall return on investment by allowing deductions for property expenses, depreciation, and capital gains tax advantages, extending beyond rental income.

DealWorthIt can be your powerful ally in navigating the complexities of real estate underwriting, especially when considering the tax implications. Our software offers the following:

• In-depth property analysis: We go beyond just the property value, taking into account potential tax benefits based on your specific situation.
• Tax-focused scenario modeling: Visualize how different ownership structures and holding periods can impact your tax liability, allowing you to make informed investment decisions.
• Seamless integration with tax professionals: Easily share your DealWorthIt reports with your tax advisor for a smooth and comprehensive financial evaluation.