The real estate market is said to be one of the best investment opportunities worth checking out right now. It’s a long-term endeavor requiring time and dedication but its rewards make everything genuinely worth it over time. If you’re eager to purchase your first investment property, you must be familiar with some crucial points to guide you in making the right decisions especially regarding taxes and other government responsibilities.
The property prices are likely to fluctuate now and then without warning. With this in mind, property values might skyrocket but can also plummet in a blink of an eye. Depending on the properties you’re planning to invest in, seeking the services of a reliable and competent private real estate investment company is a good starting point. They can help you manage your real estate investments more effectively to ensure high profits.
As part of investing in real estate, you should also consider the tax implications of all your transactions. One way to save on money is to implement the appropriate tax-planning measures to save on paying taxes.
For instance, some tax obligations you might have to pay as a real estate investor include capital gains tax, property tax, and income tax. Luckily, there are ways to help you minimize your overall tax liabilities as an investor.
If you’re one of the first-time real estate investors eager to start building up a portfolio of properties and save on money, the following are just some helpful tax-saving tips to consider.
Get Organized
If you’re eager to save money during the annual tax season, an initial step is to keep everything organized, especially if it’s you haven’t handled investment properties before.
Once you earn a substantial profit from your real estate deal and are likely to become subject to audit, you need to prepare all your receipts, documents, and all the proof relating to your business transactions.
If you sell, purchase or refinance any real estate, you’ll receive a HUD-1 Settlement Statement. It’s a standard real estate closing statement by the government which breaks down all charges on the borrower and seller. When preparing your current tax documents, always include this document since it contains essential tax return details. Also, if you need help gathering all the necessary proof of business transactions, work with a reliable tax specialist to organize the documentation for you and make the process more convenient.
Qualify As A Real Estate Professional
Generally, when you have rental properties and earn income, it’s considered passive unless you become a certified real estate professional for tax purposes. This move makes the earnings you’ve made from managing your properties as non-passive income.
Once you qualify as a real estate professional and participate in rental activity, you’ll enjoy deductions for all your losses. Ideally, you need to spend more than 50 percent of your time along with 750 hours engaging in real estate activities to be able to get a tax cut.
Make sure to check with your state’s tax agency about the qualifications you need to meet to become a real estate professional. That way, you can get the most out of your tax savings in the long run.
Create A Self-Directed IRA Account
An individual retirement account (IRA) is retirement savings account with tax benefits a person can use to save and invest long-term. Generally, a holder of an IRA account will get a penalty for utilizing the funds before they turn 65 years old. However, the Internal Revenue Service (IRS) has a few exceptions, especially for the purchase of real estate properties.
If you’re an IRA holder, you can fund your real estate purchases without penalties if you return the profits you gain to the same account.
This approach provides two benefits, especially for first-time investors:
- Serves as a source of funding to secure a rental property; and
- The money you return to your IRA account has the same tax differential treatment.
Thus, to set up your self-directed IRA account, find a trustworthy custodian who will be responsible for safekeeping the assets in the said account. Pick the real estate investments you want to add to your account. Look for a broker who can purchase the real properties for you. Aside from the buying process, they can help you manage the mortgage loan process for your real estate investment. They can also serve as a financial advisor who can help you deal with the tax implications associated with your mortgage. Once you’ve bought the investments, your IRA account custodian can perform the transactions on your behalf.
Hold On To Properties For More Than A Year
Another way to save money on taxes with your real estate properties is holding on to them for more than a year.
When you hold properties for more than a year, you’re going to pay taxes at the long-term capital gains rate. This is relatively lower than the ordinary income tax rate.
Holding on to a real estate property for periods longer than a year will lessen the chances for the IRS to consider you as a dealer in which your earnings are subject to double Federal Insurance Contributions Act (FICA) taxes since they consider you as a self-employed individual.
Maximize Your Deductions
In real estate investing, one of the advantages is that all your expenses are tax-deductible. If you want to lessen your costs when managing your real estate properties, you can deduct the following:
- Insurance;
- Mortgage interest;
- Maintenance costs;
- Property taxes;
- Advertising expenses;
- Property management fees;
- Supporting tools, software expenses;
- Home office expenses;
- Mileage and travel expenses;
- Depreciation; and
- Pass-through deduction.
An advantage is that you can take the standard deduction where you no longer need to break down the deductions and gain a cut back on your total taxable income.
If you want to work on this aspect efficiently, try researching what tax deductions you can claim to lower your taxes. Additionally, working with a professional accountant is also highly advised.
Allow Your Properties To Depreciate
One of the tax-saving strategies you can utilize is depreciation. It works best for rental property owners, allowing them to counterbalance the inherent loss of value of a property over time.
The IRS provides real estate investors the chance to exclude the depreciation cost on a residential property. With depreciation, it’ll enable an investor to recognize the net loss on a property due to wear and tear even if you’re gaining a positive cash flow.
Every year, you can minus the value of any improvements or renovations such as roof replacement or basement finishing to pay lower taxes. Compute by dividing the total real estate-related costs and deducting the outcome from ordinary taxable income for the current year.
Remember that if you have a higher tax rate, you can save more on taxes when taking advantage of depreciation expenses.
Make The Most Out Of The 20% Pass-Through Deduction
As one of the provisions of the Tax Cuts and Jobs Act (TCJA), small business owners, including real estate investors, are allowed to deduct 20% of domestic qualified business income (QBI) from a pass-through entity to help lower own the taxes they’ll need to pay.
Generally, you’ll gain a deduction on the total number of qualified items of income, deduction, gain, and loss by considering your business. It’s noteworthy that like all tax deductions, there are different terms and conditions for a business owner to avail of this perk.
Put Off Taxes With A Like-Kind Exchange
The IRS code Section 1031 or the 1031 Exchange permits real estate investors to postpone or defer paying taxes if they sell a property for a profit and reinvest in a similar one within a prescribed period of time.
The approach makes it possible for real estate investors to sell properties without getting a tax penalty right away, which is an advantage for those trying to balance out any resulting capital gains from the sale. There’s no maximum on the number of times you can take part in a 1031 Exchange.
Final Thoughts
The abovementioned tax-saving measures play a crucial role along with others throughout your fruitful real estate venture. The capability to balance out income taxes, even a certain percentage, will allow you to safeguard your profits from taxes. In real estate investing, you’ll enjoy good profits with your investment properties while saving money at the same time.
