What Are the Best Real Estate Investing Tax Strategies?

real estate investing tax strategies

More than 45% of renters pay rent equal to 30% or more of their gross household income. Investing in real estate is a potentially profitable business. But only if you utilize smart tax strategies.

While real estate investments allow you to generate passive income and build wealth, the tax implications can sometimes catch you off guard. Without a proper understanding of how real estate taxes work, you can end up paying more than necessary. This is why you need to know the tax implications that come with it.

When you implement the right real estate investing tax strategies, you can legally reduce your tax burden. This allows you to keep more of your hard-earned money. Below is a guide that explores important tax strategies that can help you save.

Take Advantage of Depreciation

Use depreciation as a savvy tax strategy. As a real estate investor, it allows you to gradually deduct a portion of a property’s value over time. This deduction serves to acknowledge the wear and tear your property undergoes.

To illustrate, the IRS designates a residential building’s lifespan as 27.5 years. This translates to you being eligible to remove 1/27.5 or roughly 3.636% of your assets value each year for the initial 27.5 years of ownership. The calculated percentage can then be deducted from your taxable income.

When you capitalize on depreciation, you can lower your tax liability. If you own rental properties, this is an ideal strategy.

Use 1031 Exchanges

When pursuing other real estate investments, capital gains taxes can eat into your profits. But with a 1031 exchange, you can postpone these taxes.

This provision in the tax code allows you to defer capital gains taxes when you sell a property and reinvest the proceeds into another property of the same kind. It’s a smart move if you want to upgrade or diversify your holdings without facing immediate tax consequences.

However, navigating the ins and outs of a 1031 exchange can be complex. There are specific rules and timelines you must follow to qualify for tax benefits. Here are some requirements for a 1031 exchange:

  • The properties must be like-kind
  • The properties must be held for investment or business purposes
  • The replacement properties must be identified within 45 days of selling the original property
  • The replacement properties must be acquired within 180 days of selling the original property

Working with a qualified intermediary will ensure you comply with all the requirements. These professionals specialize in facilitating 1031 exchanges. They can guide you through the process step by step.

Create a Real Estate Professional Status

To maximize your real estate investments and reduce your tax burden, consider becoming a qualified real estate professional. This status offers substantial benefits. It allows you to deduct a limitless amount from your taxable income in a single year.

What’s more, it opens the door to offset losses from your real estate business against other sources of income. This will help reduce your overall tax liability.

You need to meet two essential criteria to qualify:

  • Dedicate more than 50% of your operational hours to working in real estate
  • Clock at least 750 hours working on real estate trade

While the advantages are compelling, not all real estate investors can claim this beneficial tax status.

Opt for a Self-Directed IRA

Another smarter way to invest in the real estate industry while enjoying tax advantages is through self-directed Individual Retirement Accounts (IRAs). You can establish your very own self-directed IRA and leverage it to make tax-free real estate investments.

However, the process isn’t as straightforward. To start, involve a custodian or trust company. They manage your self-directed IRA, funded with transferred assets.

Then, establish a legal entity (like an LLC) for property ownership. The self-directed IRA invests in this entity, aligning with your chosen investment. For financed properties, ensure “nonrecourse” loans to reduce individual liability.

Remember only non-financed portions enjoy IRA tax benefits. Conventional IRA rules apply also apply. You will not withdraw before 59.5 and mandatory withdrawal start at age 72.

Take Advantage of Rental Property Deductions

Investing in rental properties offers a range of tax benefits that can impact your bottom line. There is an extensive list of tax-deductible expenses that can work to your advantage. You can deduct:

  • Mortgage interest
  • Property management fees
  • Legal fees
  • Maintenance costs
  • Advertising expenses
  • Property taxes and insurance
  • Other real estate support expenses

As an investor, you can still access the standard deduction. This means that many of these deductions don’t require itemizing your expenses. They directly reduce your overall taxable income.

To harness the full potential of these deductions, thorough research is important. Discover the precise tax deductions you’re eligible for and curb your tax liabilities. Accurate record-keeping is also beneficial.

Hold Properties for More Than a Year

Opting to hold onto properties for more than a year can help you reduce your tax obligations. When you possess an asset for less than a year and then sell it at a profit, the resulting gains are often subject to your regular income tax rate.

Don’t engage in frequent property flipping within a year. It can lead the IRS to classify you as a self-employed “trader.” As a result, you can expose your earnings to twofold FICA taxes.

To avoid this, extend your ownership duration to more than one year before selling. This shift in timing can reclassify your profits from standard income to capital gains. This way you are subject to a significantly lower tax rate of 15%.

If you practice house flipping, consider renting out the properties for a one-year tenancy term before selling. This approach can help you reduce your tax liability. You can also gain a stream of cash flow through rental income.

Master Real Estate Investing Tax Strategies Today

Understanding how to invest in real estate is vital. It helps you implement the right real estate investing tax strategies, saving you money.

At Reedy and Company, we’re here to help you navigate real estate investing. Our experienced team understands the ins and outs of real estate taxation. Let us transform your real estate investments into a tax-efficient wealth-building powerhouse.

Feel free to contact us now to learn more.