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8 Tax Tips For Real Estate Investors

Posted On Monday, 08 November 2021 20:28
8 Tax Tips For Real Estate Investors

Investing in rental real estate can be a great source of income and appreciate your asset value. However, getting the most out of your investments requires careful planning to avoid unfavorable tax consequences. You will need to consult with a real estate professional or tax accountant before making any big decisions that may impact your property taxes. Here are 7 tips for avoiding tax problems with rental real estate.

Take tax deductions for expenses related to rental property

You can claim deductions for property expenses, such as mortgage interest, property taxes, improvements, and depreciation. Generally you are permitted to deduct your rental property’s operating expenses in full in the year they were paid or incurred. However, there is a special rule for real estate professionals. If you rent out your property part of the year and use it as a residence the rest of the time, you can deduct expenses based on the number of days rented vs. total days owned.

Calculate depreciation on residential rental properties

Depreciation allows you to recover from income certain costs associated with leasing real property. Depreciation is allocated on a straight-line basis over a recovery period that begins on the first day of the month you place the property in service and ends on the last day of the month you dispose of it. Residential rental property has a recovery period of 27.5 years, which means that if you purchase a property on January 1st, you can deduct the same portion of the purchase price each month for 27.5 years.

Know the difference between capital gains and ordinary income tax rates

Typically, your rental property will be considered a capital asset by the IRS. When you sell a capital asset, any profit is taxed at either short-term or long-term capital gains rates, depending on how long you hold the asset before selling it. For most folks, these rates are lower than ordinary income tax rates. However if your rental property is considered a business by the IRS, any gain will be taxed as ordinary income instead of capital gains.

Make sure you have a good tax accountant

Tax rates for real estate investors may be different than your personal income tax rate. For this reason, it is important to work with an accountant who specializes in taxes for rental properties or small businesses.

Your tax accountant should also be familiar with sales tax nexus rules and how they can impact real estate investors.

Check your state's rules to get the most out of your investments

State law differs regarding the taxation of rental properties. For example, some states allow deductions for property taxes and other expenses that cannot be deducted at the federal level. Be sure to check with your state’s taxing authority before filing for real estate tax deductions.

Consider other deductions available for real estate investors

While real estate investors typically make money through rental property appreciation and depreciation, there are other ways to claim tax deductions for your business. For example, you can write off any interest paid on money borrowed to purchase rental properties. You can also deduct the cost of remodeling and repairs as a business expense, even if the expenses would otherwise qualify as personal deductions.

Know when to sell to avoid paying capital gains taxes on investment properties

One way you can reduce the amount of capital gains tax you pay is by selling your property before the end of the year you purchased it. This is known as a Section 179 election and allows you to write-off up to $250,000 for single filers ($500,000 married filing jointly) of business equipment in one year—including real estate—if certain conditions are met.

Consider using an installment sale agreement

An installment sale agreement is a way for an individual, trust, or C corporation to sell the property and receive payments over time. One of the primary benefits of this type of agreement is that you can claim all depreciation deductions during the term of your agreement while the buyer takes their yearly capital gains exclusion. A word of caution: If you sell more than 3 properties using this method in any given year, the agreement may be considered a “dealer disposition” and you will not be able to take advantage of installment sale treatment.

Conclusion

Taxes can be complicated and there is a lot of information to consider when owning rental property. Be sure to take the time to consult with a tax professional before making big decisions.

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