While there are many benefits of owning real estate, the tax advantages are often overlooked by potential investors. Today we’re going to explore the tax advantages you’ll notice after making a property investment in the future, which can assist you in growing long-term wealth.
The most common tax advantage that anyone can make use of when investing in real estate is deducting expenses from their taxes. These will vary depending on your personal situation and the property you invest in but commonly include property tax, insurance, mortgage interest, management fees, and property repairs. You could also include advertising expenses, such as the cost to list your rental on the market.
If you opt to open up an LLC or LP, you will also be subject to tax deductions related to your business operations. You could deduct accountant and attorney fees and business equipment such as laptops and office furniture. Travel expenses, education, and meals can also be deducted as business expenses. To make the most of these tax deductions, ensure you are keeping good records throughout the year ahead of filing your taxes.
Cost Segregation and Accelerated Depreciation
The wear and tear that occurs to buildings as they age are referred to as depreciation. The IRS allows for a deduction each year based on accelerated depreciation, which is defined by the useful life of the property you own. Residential property has a useful life of 27.5 years, but this increases to 39 years if you invest in commercial property. However, if you don’t plan on owning the business for that length of time, cost segregation can still be used to your advantage.
Naturally, some items in your property will outlive others, such as carpets and flooring. Cost segregation offers you the opportunity to expense these items in the earlier years of your investment over a period of five, seven, or 15 years. Accelerated depreciation allows you to take this higher deduction immediately, reducing your tax bill. It’s a great option for new investors, who may be struggling with cash flow during the early stages of their investment.
The government develops various initiatives to incentivize investors. 1031 exchanges can be used indefinitely, and they reward individuals who reinvest their real estate profits. You’ll need to buy a new property of equal or greater value to your previous one, and then you can exchange these properties for tax purposes. This results in you deferring the capital gains tax payment on the property sale. When you do eventually cash out your profits, you will have to pay the tax that you owe, so it’s important to keep this in mind. However, it’s a great way to minimize your tax payments currently while still benefitting from owning a rental property.
The US Department of the Treasury designates opportunity zones, which are low-income areas of land. This encourages investors to stimulate the economy in this area by offering them tax breaks. Your unrealized capital gains are placed into a Qualified Opportunity Fund, which helps to improve the area. As long as you follow the guidelines of the program correctly, you’ll be offered many tax advantages. You’ll be able to defer paying capital gains until the year 2026 and grow your capital gains depending on the length of time you hold the fund. For anyone who opts to invest in the fund for over ten years, you’ll avoid paying capital gains entirely.
Avoid FICA Tax When Self-Employed
Finally, for anyone who is self-employed, you’ll usually need to pay the employee and employer parts of FICA tax to cover Medicare and Social Security. As an owner of a rental property, you’ll qualify for a tax break by avoiding the FICA tax on your rental income. This is one of the least commonly discussed tax advantages of real estate investment, but it can benefit anyone who is self-employed greatly, keeping thousands of dollars each year in your bank account.
As you can see, there are so many tax advantages of owning real estate. Paired with the potential income you can earn from renting your commercial or residential property, real estate is a great way of setting yourself up financially for the future. The tax savings you make can be used to plan your future investments and help you to build your property portfolio quicker than you thought was possible. In order to take advantage of any of these tax advantages, make sure you thoroughly research your eligibility to make the most of any opportunities available to you as a real estate owner.