Tax deductions are among the many rewards you will get when you invest in real estate. Surprisingly, lots of people are still not aware of these many tax benefits that can help lower taxes on their investments. Most of the benefits apply in the USA and several other countries around.
In this article, I will discuss all the common tax benefits you can get from your real estate investment if you take the right steps. Without wasting any more of your time, let’s get into this.
One of the first real estate tax benefits is deducting depreciation costs as an expense. This reduces your taxable income, which can significantly lower the investor’s annual tax payments. All real estate assets can deduct depreciation costs due to the assumed wear and tear. This cost may vary depending on the kind of property you have and its assumed expected lifetime.
For instance, homes are expected to last up to 27.5 years, whereas commercial properties are expected to last up to 29 years. To get the annual depreciation cost, you simply have to divide the total cost of the property by the expected lifetime. For instance, if you buy a commercial property at $290,000, its annual depreciation will be $290,000/29 = $10,000. So, the law allows you to deduct $10,000 depreciation fees on your asset.
When buying a property, it is important to know its expected lifetime, as this will affect the depreciation costs that you can deduct from your taxable income. Depreciation deductions can significantly lower the investor’s annual taxes.
The law also allows real estate investors to deduct management, maintenance, and operational expenses from their taxable income. Some real estate investors can end up paying no taxes if their expenses, including depreciation costs, exceed their taxable income. Management and maintenance expenses may include property taxes, property insurance, mortgage interest, property management fees, and cost to maintain and repair the property within that financial year.
The operational business expenses that investors can deduct from their taxable income include advertising, office space, procuring business equipment, legal and accounting fees, staff travels, and more. For instance, if your total rental income is about $30,000, and the total expenses that qualify are about $10,000. Your taxable income will be $30,000-$10,000 = $20,000. You can also deduct the annual depreciation costs to further reduce the taxable income.
This involves writing off a certain percentage of your qualified business income from your personal taxable income. In the USA, business owners can deduct up to 20% from their rental income. This will lower their taxable personal income by up to 20%. That means someone who earns$40,000 from rent can deduct up to $8,000, so their new taxable income will become $32,000.
These rules may vary depending on your country and state. So, consult the relevant authorities for further guidance on how to take advantage of the pass-through deductions. Tax laws are also frequently updated, so make sure to check out any changes that may affect the pass-through deduction.
When you eventually sell your property for more money after a couple of years, the government will tax the profits gained. However, these profits are not taxed as income but rather capital gains. Remember, income taxes are usually higher than property gains taxes. So, if you are in the business of buying and selling properties, you can end up paying fewer taxes. If you play your cards right.
However, you will need to hold the property for longer than one year if you want to enjoy these tax benefits. Profits generated from properties sold after less than one year are taxed as income. Selling the property after the first anniversary of purchase should be the goal if you want to enjoy the capital gains advantage.
The US has some tax incentives that are meant to encourage investors to reinvest the money they generate from property sales. For instance, if you sell a property and buy a new one that is of the same or more value, the profits gained from the previous sale will not be subjected to capital gains taxes according to the 1031 Exchange incentive.
That means it is possible to buy and sell multiple properties without paying capital gains or income taxes. You can always cash out your profits by selling any of your properties later. However, these profits will be subjected to income tax or capital gain taxes depending on how long you owned the property.
The FICA tax is paid by the employer to cover the Social Security and Medicare of their employees. With real estate, you are self-employed, so you won’t have to pay the FICA tax. The money you get from your own rental property is not classified as income, so it is not subjected to the FICA tax.
Let’s take a look at this example; if you earn $50,000 per year from your food delivery business, you will have to pay 15.3% FICA tax, which lowers your income to $42,350. Your $50,000 won’t be taxed if it is earned from rental income.
The US government put up this fund to encourage real estate investors to invest their money in rural areas and other less developed places in the country. There are over 9000 areas in the US that fall under opportunity zones. Real estate investors in these areas can get several years of tax breaks, enabling them to generate tax-free income.
However, it should be noted that most of these areas don't have a lot of economic activities going on. So, the properties in these areas don’t generate that much income. However, some of the opportunity zones have potential and could experience rapid development in the next couple of years. We recommend seeking expert advice when choosing the economic zones in which to invest your money.
Those are some of the common tax advantages that cut across most real estate investments. Fully enjoying these tax deductions may require you to get some expert guidance from experienced real estate financial advisers. It won’t hurt to pay a small consultation fee if the results of the knowledge will save you thousands of dollars in taxes.
It should also be noted that these tax advantages may not apply in some countries and states. Make sure to crosscheck with the relevant authorities to find out the ones that apply to the area where your property is located.
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