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The Incredible Tax Benefits of Real Estate Investing

Investing in real estate can be a great way to diversify your investment portfolio and gain income. There are some tax advantages you can enjoy from your real estate investment. These are some of the top advantages you can enjoy when you invest in real estate.

Depreciation

When it comes to taxes, the IRS uses depreciation to cover real estate wearing down over time. The IRS has determined that nonresidential and residential rental property begins to depreciate after 27.5 years. This depreciation can save you money on your taxes. For example, if you have a property with a $5,000 taxable income from rent and have a 25 percent rate on your federal income taxes, here is what your tax bill might look like with and without depreciation.

Without Depreciation:

$5,000 x 25% = $1,250 taxes owed

With Depreciation:

$5,000 – $3,000 depreciation expense = $2,000 taxable rental income

$2,000 x 25% = $500 taxes owed

Tax Savings = $1,250 – $500 = $750

Deductions

When you think of tax benefits, deductions are most likely the first thing that pops into your head. You can deduct a few different expenses from your investment to help with your taxes, including:

  • Property taxes

  • Mortgage interest

  • Property management fees

  • Insurance for the property

  • Repairs, improvements, and maintenance

  • Advertising

Live-in Flip

If you are flipping houses, and you live in the property for at least two years while working on it, you can save a lot on the capital gains taxes. For a single person, the first $250,000 is tax-free, and $500,000 for married couples. You have to own the house for at least five years, but you only have to live in it for two of those years.

This does mean you will be moving every two years and living in a construction zone constantly, but it can be a pretty easy way to earn money that is not taxable.

1031 Exchange

This is a legal strategy that investors can use to bypass paying taxes on the property they sell. The 1031 exchange is named for Section 1031 in the IRS tax code, and it allows someone to basically sell a property and use the profits from it to buy a new property, deferring paying real estate taxes until the next property gets sold.

FICA Tax

This tax benefit can save you on your income from rental properties. The Federal Insurance Contributions Act (FICA) is a 50/50 tax split of 15.3 percent between and employer and their employee. If you are self-employed, you pay the entire thing, but you may be able to offset it, depending on how your real estate business is structured.

Capital Gains

When you sell a property for more than you bought it for, the profit will be considered capital gains, which often has a low tax rate. There are short-term and long-term capital gains.

The short-term is a property you owned for a year or less, and — depending on your tax bracket — can range from 10 percent to 37 percent.

The long-term gains are held for over a year and those taxes can range from zero percent to 20 percent.

References

“Like-Kind Exchanges - Real Estate Tax Tips.” Internal Revenue Service, www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-real-estate-tax-tips.

“Publication 946 (2019), How To Depreciate Property: Internal Revenue Service.” Publication 946 (2019), How To Depreciate Property | Internal Revenue Service, www.irs.gov/publications/p946#en_US_2019_publink1000107302.

“The Incredible Tax Benefits of Real Estate Investing.” Mad Fientist, www.madfientist.com/tax-benefits-of-real-estate-investing/.

“Topic No. 701 Sale of Your Home.” Internal Revenue Service, www.irs.gov/taxtopics/tc701.

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