Real estate investment has been absolutely booming since the pandemic began.
Last year, the average home-price gain was $68,843. That is the highest gain since 2005, making it the best time to sell a house in 15 years.
There is no doubt that the industry is the best that it has been in a long time for a seller. So, maybe you’ve thought about buying real estate property too.
With that, of course, comes real estate tax benefits.
But, what are those benefits? Do the benefits make it worth investing in real estate?
Below are eight of the best tax benefits for real estate, several of which will blow your mind—because they’re unbelievable. Let’s dive in.
1. Deductions
If you purchase a piece of real estate as a rental property, then you are allowed to deduct a wide range of expenses.
The closing costs you paid to acquire the property can be written off as a business expense, with some being immediately deductible and others having to be realized over time.
Of course, you can also deduct property taxes, as well as the costs you pay to maintain the property. This can be utilities such as heat, air conditioning, water, gas, electricity, internet, home improvements, renovations, and more.
The point being, any money you put into the property is an expense that you can write off on your taxes until you sell the property.
The only thing to note is that if you are living on that property, this becomes more complicated, because you can only deduct the portion of the property that you are not using as living space.
2. Depreciation
Another tax benefit for real estate is the fact that you can depreciate your asset. Depreciation is tax rule that acknowledges that there is wear and tear on a property over time. The general rule on this is that a business is allowed to depreciate residential property you own at 3.636% per year for 27.5 years. (1 / 27.5 = 3.636%)
An example would be if you bought a house for $500,000. With that value, you could have a depreciation rate of $18,180 per year.
This means you can write off that $18,180 as an expense, and lower your overall income for a year. The catch with depreciation is that you have to be using the property for at least a year for business reasons.
So, if you are renting the property out and plan to hang onto the place for many years, this benefit can save you tens or even hundreds of thousands of dollars in taxes.
To further benefit from depreciation, you can hire an accountant to do a Cost Segregation Study. This is a way of accelerating the depreciation you can take on a property so you can benefit from it faster.
The purpose of this approach is to depreciate some components within a property over shorter time period than 27.5 years, such as 5, 7, or 12 years, for example.
3. No Self-Employment Tax
The IRS considers most types of rental real estate not to be self-employment but to be an investment. This is beneficial, because people who are considered to be self-employed get taxed twice on FICA compared to normal W-2 employees.
FICA (Federal Insurance Contributions Act) is basically Social Security and Medicare. Normal W-2 employees get taxed 7.65% of their income to cover those two things, but self-employed people have double that tax at 15.3% of their income.
This is because people who are self-employed have to pay both the employee and business owner side of FICA.
As a real estate investor, you do not have to do this. The reason is that money received from real estate property is not considered earned income.
So, you could potentially get the freedom of someone who is self-employed without being obligated to pay that extra 7.65% in tax.
4. Capital Gains
Quite simply, this is the profit (or loss) that you receive when you sell a piece of real estate. This can be separated into short-term and long-term capital gains.
Short-term capital gains are those charged on property that you owned for less than a year.
Specifically, the U.S. IRS will treat any profit you made from a buying and selling a house in under a year (“flipping”) to be active income, instead of investment income. This means the federal taxes on your profits could go as high as 37%.
In contrast, long-term gains are taxed much more favorably at only either 0%, 15%, or 20%, depending on your tax bracket. For most people, long-term capital gains are only 15%.
5. Home Sale Exclusion Tax
This particular tax advantage is for real estate that you live in, called your primary residence.
Under this section of the IRS tax code, single filers are allowed to sell a primary residence for a gain and not pay any taxes on the first quarter million ($250,000) of profit. That is truly astounding!
If you are married, then this tax benefit doubles and you won’t owe taxes on your first half million ($500,000) of profit.
The catch here though is that the property you are selling must be your primary residence.
To qualify for this tax benefit, you also need to have lived in your home for two out of the last 5 years and not have claimed this deduction in the last two years.
6. 1031 Exchange
If you are willing to use the profit made from selling an investment property to acquire a new investment property, then this tax benefit can be a tremendous advantage. Why is this?
Because the 1031 Exchange allows your profits from a property sale to be tax-free if you use those profits to acquire a new property that is equal or greater value to your original property.
It is called a 1031 Exchange because the rules for it appear in Section 1031 of the IRS tax code. You can do this as many times as you like when buying and selling property.
But, you will have to meet a few ground rules to qualify for this benefit, including using an 1031 exchange intermediary to holds the funds from the sale of your first property until your replacement property is acquired. You can’t touch those funds or let them hit your bank account—or you’ll lose this tax benefit.
And, you’ll need to identify your new replacement property within 45 days and finalize its purchase within 180 days.
7. Borrow from Yourself, Don’t Sell (Refinancing)
Would you believe it if I told you that you can refinance the mortgage on a property to pull out thousands—sometimes hundreds of thousands or millions—in profits and not pay a cent in taxes?
For example, if you bought a property for $300K using a $250K mortgage and $50K down, but the property went up in value to $500K over time, then it is probable that a lender would allow you to refinance that property for 80% of its value.
This means you would most likely qualify for a new $400K mortgage (80% of $500K), which would pay off your old mortgage of $250K and leave you with $150K in hard, cold cash.
What’s incredible is that you wouldn’t owe a cent in taxes on the $150K in cash that you received. Not a single cent.
Why is this? It’s because you are technically getting a loan. A a further bonus, you can then deduct the cost of borrowing this money against your property’s rental income. Best of all, you can do this over and over as your property appreciates in value over time.
In short, if you can keep your property profitable while you take this loan, then it can save you a lot of money in taxes and you can have more cash on hand—without having to ever sell your property.
8. Pass Your Property to Your Heirs Tax-Free
This is a great option for those of you who have loved ones that you want to take care of after you pass on. When you die, you are allowed to pass property onto your heirs, and they do not have to pay any capital gain taxes on it.
Why is this? Well, when you die, the IRS allows your heirs to receive your property at its current value as it passes through to them as part of your estate.
Meaning, if you bought a property for $200K but it was worth $600K by the time you die, the IRS allows your heirs to “acquire” this property at its current value of $600K (called a cost basis).
This means they won’t owe any capital gains on the $400K in profit if they sell it immediately. The one exception to this is that if if your estate is worth more than $11.7 million, but this affects less than 1% of estates.
Thus, for 99% of the population, you can leave an asset that is worth seven to eight figures to your loved ones, tax-free.
Unbelievable Real Estate Tax Benefits
These real estate tax benefits are only the beginning of how you can benefit from real estate investing.
Other ways you benefit from real estate are through price appreciation, capital preservation, debt (mortgage) paydown by your tenants, and controlling a physical asset that can provide a hedge against inflation.
To learn more about finding and acquiring the cash-flow producing properties, explore the real estate section of this blog.