Are You Taking Advantage of the Top 5 Tax Benefits Available to Real Estate Investors?
It's that time of year again...
Tax season is here, and whether you're a new or seasoned investor, you may not be aware of the many tax benefits of owning rental properties. To assist you, we have compiled the following list of our Top 5 Tax Benefits of Investing in Real Estate.
Tax Benefit #1: Opportunity to reduce taxable rental income through deductions.
There are many options to reduce taxable rental income through deductions:
- Repairs and Maintenance. Generally, most rental property repairs and maintenance would be included as a deductible expense from rental income. Watch out for expenses that may be considered “upgrades” versus repairs. Upgrades are significant improvements to your rental property, such as paving a driveway, building an addition, etc. Upgrades will increase your basis in the property and will not be deductible. However, repairs and maintenance are deductible.
- Homeowners Association (HOA) and Condo Fees. Many real estate investors might avoid investing in a condo because of the high monthly fees, however, HOA and condo fees can be deductible in many cases and help offset the cost.
- Interest. You can deduct your mortgage interest from rental income.
- Taxes. You can deduct up to $10,000 in state and local taxes on your return. This includes property taxes paid on your real estate investment property.
- Depreciation. This is everyone’s favorite tax benefit for an investment property! The depreciation period is typically 27.5 years for rental properties. This deduction can have a big impact on your tax return, but make sure to consult a tax planning professional. There are detailed rules about allowable depreciation and a depreciation recapture income tax that kicks in when you sell the property.
- Insurance. You can deduct the premiums for several types of insurance that are covering your rental property.
- Services. Utilities can be deducted if they are including in the full monthly rental cost for your tenant. Other operating expenses like pest control can be deducted as well.
- Property Management and Other Professional Fees. The IRS considers property management fees, attorney, or CPA fees to be operating expenses and are allowable deductions.
Tax Benefit #2: Opportunity to deduct any rental loss against other passive income.
- Since there are so many good ways to reduce taxable rental income, you may end up showing a loss for the year. It is very common to show a loss for a rental property. According to the IRS, over half of the filed Schedule E returns show a loss. An exception known as the “Mom and Pop Exception” will allow you to deduct up to $25,000 in rental real estate losses per year if you actively participate in the rental activity and your Adjusted Gross Income (AGI) is below $100,000. Owning rental property doesn't just have to be for high-income individuals!
- For higher-income property owners, you can deduct a real estate rental loss against other passive income (other rental properties that you may own that are showing income). There are exemptions for real estate professionals that allow the deduction of rental loss against ordinary income, but be sure to check with your tax advisor to see if you qualify.
Tax Benefit #3: Income on the sale of investment property is taxed at preferential rate.
- Once you decide to sell your rental property, the IRS will tax your gain on the sale. Thankfully, the sale of property is taxed at long-term capital gains tax rates if the property was held for longer than a year. The capital gains tax rate is 15% if your AGI is between $80,000 - $496,600. It increases to 20% if your AGI is above $496,600.
- This can add up to quite a savings depending on your tax bracket. If you are in a 22% bracket and you have a profit of $100,000 from a sale, the tax would be $22,000 if it were taxed as ordinary income. The tax bill would only be $15,000 taxed at the capital gains rate.
Tax Benefit #4: Capital gains tax can potentially be deferred through a 1031 exchange.
- Paying capital gains tax is not fun! If you need to defer that tax, a 1031 exchange, also commonly known as a like-kind exchange, allows anyone to reinvest the proceeds of rental property sales into a new real estate investment. Completing a 1031 exchange will defer the capital gains tax until a property is eventually sold for cash.
- There are many rules and regulations that govern 1031 exchanges, including identifying a replacement property within 45 days and closing on a property within 180 days. Be sure to consult with a tax professional when planning to utilize a 1031 exchange.
Tax Benefit #5: The Qualified Business Income (QBI) deduction.
- The QBI deduction allows taxpayers to deduct as much as 20% of their pass-through business income. Pass-through income means income received from a business venture like a sole proprietorship, partnership, S Corporation, LLC, Trust, or Estate. C Corporations are not included.
- There are taxable income thresholds ($329,800 for married individuals and $164,900 for singles). If you are under the thresholds you can take the full 20% QBI deduction.
- If you prefer to invest in real estate via Real Estate Investment Trusts (REITs), dividends from REITs also count as income that can be deducted from using the QBI deduction.
As you can see, there are potentially many ways to maximize the profit potential of your real estate investment. Taking advantage of the tax benefits available to you is just one. When TMG Property Management Services NW manages your rental property, tax time is so much easier because at the end of the year, you will be given a report of all income and expenses for your property. Having the best property management company on your side makes all the difference in the world.
Call our rental property expert for a quote and a free analysis of your property.
Read the IRS’ Tips on Rental Real Estate Income, Deductions and Recordkeeping.
View TMG Property Management Services NW Investor Resources - including calculators, tips, and tools for real estate investors.
Learn more about this subject in our blog post: Rental Properties and Taxes - What You Need to Know.