Tips to Lighten Your Tax Load as a Real Estate Investor
Ever feel like you’re paying way too much in taxes as a real estate investor? The good news is there are plenty of legal ways to reduce your tax liability. As a real estate investor, the tax code provides some generous deductions and loopholes you can take advantage of. Whether you’re just getting started with your first investment property or have been in the game for years, implementing a few clever tax strategies can help ensure you get to keep more of the money you earn. In this article, we’ll explore six tips to help lighten your tax load as a real estate investor. From maximizing deductions to timing sales and purchases strategically, you’ll discover some simple ways to lower your tax bill and boost your bottom line. So if you’re ready to pay less to the taxman and keep more for yourself, read on.
Understanding How Taxes Apply to Rental Income
As a real estate investor, the income from your rental properties is taxable. Understanding how taxes apply to your rental income can help you keep more of your hard-earned money.
Record Keeping
Keep good records of all income and expenses related to your properties. Track both cash and non-cash items like depreciation. Come tax time, your records will make it easy to report rental income accurately.
Depreciation
One of the best tax benefits for real estate investors is depreciation. As your properties age and components like the roof or HVAC need replacement, you can deduct a portion of their cost each year. The depreciation deduction lowers your taxable income.
Expenses
Most operating expenses for your rentals like insurance, utilities, repairs, and mortgage interest are tax deductible. Be sure to track all expenses to maximize your deductions. Things like travel to and from your properties also count.
Passive Loss Rules
If your rental income doesn’t cover all your deductions, you may have a passive loss. Unfortunately, the IRS limits how much passive loss you can claim each year. Any disallowed loss carries forward to the next year.
Consider an LLC
Forming an LLC for your rental properties provides personal liability protection and may give you more flexibility with passive loss rules. It’s worth discussing your options with your tax professional.
With good records and an understanding of the tax implications of rental real estate, you’ll be well on your way to keeping more money in your own pocket and building wealth through property investment. Your trusted partners at Equity On Repeat can recommend more ways to optimize your tax strategy.
Maximizing Depreciation Deductions on Investment Properties
As a real estate investor, one of the best ways to lower your tax bill is by maximizing depreciation deductions. Depreciation allows you to deduct a portion of the cost of your investment properties each year. Let’s look at a few ways to maximize this benefit:
Accelerate depreciation using cost segregation studies
A cost segregation study analyzes your property to identify components with shorter depreciable lives, like landscaping, security systems, and flooring. Segregating these elements allows you to accelerate depreciation deductions, putting more money in your pocket sooner. Studies typically cost between $3,000 to $10,000 but can generate over $50,000 in tax savings for a $1M property.
Componentize renovation costs
When you make improvements to your properties, work with your accountant to allocate renovation costs to components with the shortest depreciable lives. Things like new flooring, cabinetry, appliances, and fixtures can often be depreciated over 5-15 years using component depreciation. Compare that to the 27.5 years for residential property and you can see the tax advantage.
Consider a cost segregation study for older properties
Just because a property is already placed in service doesn’t mean it’s too late to benefit from cost segregation. A “look-back” study can be done on properties you’ve owned for years, allowing you to amend previous tax returns and claim refunds for depreciation you missed. The savings here can be substantial, even on properties you’ve owned for over a decade.
Using these strategies to accelerate depreciation and maximize deductions is one of the best ways real estate investors can lower their tax liability each year. Work with your CPA to determine which options are right for your properties and start putting more money back in your pocket, where it belongs.
Offset Gains With 1031 Exchanges
One of the best ways real estate investors can offset capital gains and lower their tax bill is through a 1031 exchange. Also known as a like-kind exchange, Section 1031 of the Internal Revenue Code allows you to defer taxes on the sale of an investment property if you reinvest the proceeds in a new property.
To qualify for a 1031 exchange, both the relinquished (old) property and replacement (new) property must be held for investment or business purposes. You must also identify new potential replacement properties within 45 days of selling your old property and complete the purchase within 180 days. The two properties must also be “like-kind”—meaning they’re both real property held for investment. So you can exchange an apartment building for raw land, or a duplex for a warehouse.
A 1031 exchange allows you to defer capital gains taxes and continue building wealth through real estate investing. Any capital gain on the sale of the old property becomes part of the cost basis of the new property. So if you sell a property for $500,000 that you purchased for $200,000, you would normally owe capital gains taxes on the $300,000 profit. But with a 1031 exchange, that $300,000 profit is rolled over into the new property, so you avoid paying taxes on that gain.
To perform an exchange, you’ll need to work with a qualified intermediary (QI) to facilitate the transaction. The QI will handle the funds from the sale of your relinquished property to ensure you avoid taking constructive receipt of the cash, which would disqualify the exchange. The QI will then direct the funds to the purchase of your replacement property.
Using a 1031 exchange is one of the best ways savvy real estate investors build wealth over time while avoiding a big tax hit. If maximizing your returns and deferring taxes sounds appealing, a 1031 exchange could be a great option for your investment strategy.
Write Off Travel Expenses Related to Your Rentals
As a real estate investor, one of the best ways to lower your tax bill is to write off expenses related to your rental properties. The IRS allows you to deduct ordinary and necessary travel costs to check on your properties. Things like airfare, hotel stays, and meals can really add up, so make sure you’re tracking all these expenses properly.
Keep Good Records
Keep records of all your travel expenses like receipts, invoices, and statements. The IRS may ask for documentation to verify deductions, so stay organized. Record the date, amount, place, and business purpose of each expense. If any expense is lavish or extravagant, make a note of why it was necessary.
Deduct Vehicle Expenses
You can deduct vehicle expenses for travel to and from your rentals. Track your mileage and multiply by the standard mileage rate set by the IRS each year. You can also deduct actual vehicle expenses like gas, insurance, repairs, and depreciation. Keep records of dates, locations, mileage, and purpose of travel.
Meals and Entertainment
Business meals, whether dining alone or entertaining others, are 50% deductible. Keep receipts and record who you met with, where, when, and the business purpose. Entertainment expenses like sports tickets are not deductible, but meals before or after an event may be.
Travel Expenses
Airfare, train tickets, taxi fares, and rental cars to visit your properties are deductible. Keep records with dates of travel, destinations, costs, and business purpose. Hotel stays are deductible as well, so save receipts in case of an audit.
Following these guidelines and keeping meticulous records of your rental-related travel expenses can help lower your tax bill as a real estate investor. Every dollar you can deduct reduces your tax liability, so make sure you’re taking advantage of all the write-offs available to you. Your accountant can also suggest other tax strategies tailored to your unique situation.
Lower Your Taxable Income With Cost Segregation Studies
As a real estate investor, one of the best ways to lower your tax burden is through cost segregation studies. A cost segregation study examines the fixed assets in your property to determine what components can be depreciated faster. The more you can depreciate upfront, the more tax deductions you can take early on.
Accelerate Depreciation
Cost segregation allows you to accelerate the depreciation of certain building components, like cabinets, flooring, appliances, and fixtures. Rather than depreciating the entire building over 27.5 or 39 years, you can depreciate these components over 5, 7, or 15 years. This significantly increases your depreciation deductions in the early years of ownership and lowers your taxable income.
Save Thousands in Taxes
For every $100,000 in assets you can reclassify as 5-year property instead of 27.5-year property, you can generate an extra $20,000 in depreciation deductions in the first 5 years. On a $1 million building, cost segregation could produce $200,000 in additional depreciation and save you $60,000 or more in taxes over the first 5 years. The tax savings often far outweigh the cost of the study.
Talk to Your CPA
Cost segregation studies require working with specialists who understand real estate tax rules. They will examine your property’s plans, specs, and costs to determine what components can be reclassified into faster depreciation schedules. Then they provide an official report you submit to the IRS to justify the changes in depreciation.
It’s a smart strategy for new or experienced real estate investors. By accelerating depreciation and taking bigger tax deductions upfront, you can lower your taxable income in the early years of ownership and keep more money in your pocket. If you haven’t looked into cost segregation yet, talk to your CPA today about how it could benefit your real estate portfolio.
Conclusion
In the end, you have the power to save thousands each year on your real estate tax bill. With strategic planning and the right tools, you can keep more of your hard-earned money. Don’t let the tax man take any more than necessary. Take action today by implementing these key tips. Set up separate business entities, maximize deductions, defer capital gains, and take advantage of special programs. Knowledge is power, so do your research and consult experts as needed. By making smart tax moves now, you’ll thank yourself come April 15th. Keep fighting the good fight, investors, and good luck lightening your tax load!