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Many experts have reported the real estate industry to be the best return on investment. Financial professionals have run study after study and have concluded that real estate can provide higher returns than stocks, bonds, or other highly boasted strategies.
There are many benefits of investing in real estate beyond the ROI. Some of the best benefits involve paying lower taxes—and in some cases, no taxes—whatsoever.
There are eight unbelievable tax benefits that you need to know about when it comes to investing in real estate. Learn these real estate tax laws, because they have the potential to change your life, forever.
Tax Benefits of Investing in Real Estate
There are many tax benefits that come with investing in real estate. You rarely get every tax benefit of owning real estate all at once, but you often can stack several of them.
Sometimes, you have to get one tax benefit in place of another. You may also give up multiple benefits for one large benefit.
1. Property Depreciation
Homes depreciate in value over time, meaning that the value becomes smaller over time. The Internal Revenue Service (IRS) has determined that residential real estate depreciates in about 27.5 years.
You do not have to physically pay for the loss in the value of your property, but it is a loss that you will notice if you’re selling the property later. Therefore, the depreciation of your property is considered an expense.
The concept of depreciation applies to many other things like vehicles. Those depreciation timelines are different though. However, real estate benefits from depreciation more because of the outstanding costs of owning a property.
Unfortunately, you don’t escape the property’s depreciation value forever. If you’re ever looking to sell the property, you’ll likely have to reclaim the property’s depreciation value and pay taxes on that.
This is likely an incentive to make sure that people are keeping the real estate that they buy for a long time rather than turning around and selling it quickly.
2. Appreciation
If you do choose to hold onto the property for a long time, you can build your net worth with little tax exposure. The IRS doesn’t tax this appreciation.
The best thing to do if you don’t want to worry about paying taxes is to just hold onto the property. Don’t sell.
Selling the property comes with many fees because of commissions, taxes, and transactions. You’ll lose the ability to grow that money if you sell the property.
Holding onto the property ensures that you’re avoiding depreciation tax, selling costs, and other hidden fees. If you’re thinking of selling, think again.
3. FICA Tax
Like many other forms of income, real estate income is exempt from paying FICA, or payroll, tax. This means that the income that you make from real estate does not go towards paying taxes for Medicare and Social Security.
If you were to work as a regular employee, you’d be paying 7.65% of your income to Medicare and Social Security. If you were self-employed, you’d be paying 15.3% towards the same funds.
However, those earning money from real estate investment will avoid this tax completely. They don’t pay one cent towards FICA taxes.
This tax break is a great incentive for those who are currently involved in real estate investment. For those who haven’t started investing in property yet, it is a great motivator.
4. Capital Gains Tax
The capital gains tax is for those who have sold a non-inventory asset, like a house, precious metals, stocks, and other assets. The long-term capital gains tax is for those people who owned the asset that they sold for longer than one year.
The long-term capital gains tax is between 0% and 20% depending on what tax bracket you’re in. In general, the capital gains tax costs less than typical income taxes.
This is because the long-term capital gains tax rate tops out at 20%, while the federal income tax rate can climb as high as 37%. Of course, this can change along with shifts in the political climate.
Low capital gains rates are extremely advantageous for those who sell real estate.
5. 1031 Tax-Free Exchange
The 1031 tax-free exchange is named for the tax law that the principle is stated in. The 1031 tax-free exchange rule says that money that you make from one property can be used to pay for the next property.
Compounding investments like this can have your money growing at an exponential rate.
This tax-free strategy is a little more meticulous to follow. You must follow guidelines and be a real estate investor rather than a house flipper. Even though the process may seem difficult, the end is definitely worth the means.
For example, you may make $10,000 on a property. If you reinvest that $10,000 in another property, you could make $200,000 from it. If you keep reinvesting, this will only keep growing.
For those who may have heard of this rule before, you should know that there has been a change recently. You can only apply this rule to investing in the land and house itself. This does not include appliance, furniture, or other things you may spend money on for the property.
6. Home Sale Tax Exclusion ($250,000/$500,000)
According to the IRS, if you live in the home that you’re selling you can avoid paying tax on the first $250,000 worth of profit. If you’re married filed jointly, that doubles to $500,000. You must live in the home for two of the next five years to avoid the tax.
For example, if you and a spouse bought a house for $300,000 and sold it a couple years later for $800,000, you wouldn’t have to pay tax on a half million dollars in profit. Pretty incredible, right?
For obvious reasons, the public calls this tax exclusion the “$250,000/$500,000 Home Sale Tax Exclusion.” However, accountants like to call it “Topic No. 701” because that’s its number in the IRS tax code.
7. Mortgage Interest Deduction
If you own a primary or secondary home, you will also benefit from being able to deduct your mortgage interest.
Meaning, you can reduce your taxable income by the amount of money you’ve paid in mortgage interest during the year (up to a limit).
If you bought your property prior to December 15, 2017, you can deduct the interest paid on the first $1 million of mortgage debt. Meaning, if you put $100K down to buy a house and acquired a mortgage for $1 million (total purchase price of $1.1M), you could write off all of your mortgage interest.
However, if you bought your home after December 15, 2017, then you can only deduct mortgage interest up to $750,000 of mortgage debt.
When it comes to rental properties, you can also deduct mortgage interest, although additional requirements can apply.
8. Rental Property Tax Advantages
If you own rental property, you get several tax deductions on several different expenses that you may have. These include maintenance and repairs that you may need to do on the property, utility prices, legal and professional fees, and travel and transportation.
In addition to those benefits, you’ll see tax deductions of insurance premiums, value depreciation, loan interest, and property tax.
There are a lot of expenses that you have to make when you own a rental property, but these amazing tax benefits could convince anyone that it’s an intelligent investment idea.
Benefits of Investing in Real Estate
If these tax breaks sound great to you, you should consider getting involved in real estate investment. You can make heaps of money and achieve multiple flows of income through buying and selling real estate.
Better yet, you can have a ton of fun doing it.
To learn more, read these tips for becoming wildly successful within the real estate industry.
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