Real estate investing comes with significant tax benefits. Find out how to identify the top tax strategies for maximum benefit and how to use them to your advantage come tax time.
As with all deductions, consult your tax accountant for the most up-to-date on what is/is not allowed regarding tax deductions related to real estate investing.
Self-Employment / FICA Tax
First and most straightforward, you can avoid payroll tax if you own rental property. That’s because the income from your rental property is not considered earned income. In addition to avoiding tax outright, there are numerous deductions available to real estate investors.
Expense Deductions
Real estate expenses directly related to your investment, such as property tax, insurance, mortgage interest, and maintenance or management fees, are deductible. These actual expenses are typical deductions the IRS considers “ordinary and necessary” to sustaining your real estate investment. However, a few deductions to which you may be entitled are often overlooked.
If you spend time traveling to and from your investment property, those miles may be deductible.
You also may be able to deduct non-mortgage interest fees related to your investment property. For example, loan or credit card interest incurred in connection with your investment property are deductible business expenses. Legal and other professional fees directly associated with the investment property are also deductible.
Depreciation
Suppose you have real estate investment property that produces income. In that case, you can deduct depreciation of that property as an expense. The depreciation deduction lowers your taxable income.
The IRS sets the life expectancy of real estate – 27.5 years for residential property and 39 years for commercial property – which determines the deduction to which you are entitled.
Incentive Programs
Some incentive programs make it possible to defer real estate taxes. For example, a 1031 exchange allows real estate investors to avoid paying capital gains taxes when selling an investment property and reinvesting in a replacement property. Investors can reinvest proceeds from the sale of one property into another property. This transaction must occur within a specified time to avoid capital gains taxes (the taxes on the growth of an investment when it is sold).
Suppose your real estate property qualifies as an “opportunity zone,” a low-income or disadvantaged parcel. You may be able to further defer capital gains tax, grow your capital gains, or entirely avoid capital gains.
These perks are time-dependent, which is something your qualified accountant can help you navigate.
Capital Gains
So, what if you sell your real estate investment property? Suppose you can wait until you’ve held the property for at least one year. In that case, you may be able to pay a much lower capital gains tax than if you sold sooner, or you could avoid capital gains altogether. That’s because holding onto a property for more than one year makes it a long-term investment. With that, you will pay a lower capital gains tax rate. If your income is under a certain amount (check with your accountant because these rates tend to change year to year), you may be able to avoid the tax entirely.
Qualified Business Income (QBI) Deduction
More commonly known as the pass-through deduction, this tax break encourages entrepreneurship. This deduction allows certain entities to deduct up to 20 percent of their business income. So, businesses like LLCs, S-corps, and sole proprietorships benefit. You may be wondering how this type of deduction helps real estate investors. If you own rental properties, you technically operate a small business by IRS standards. Therefore, you are entitled to the pass-through deduction. The deduction also benefits real estate investment trust investors (REITs) because REITs are technically considered pass-through entities. The deduction is not scheduled to end until 2025, so there’s still time to take advantage of this deduction.
Deductions like QBI and others on this list, such as depreciation and expense deductions, mean that real estate investment can significantly reduce tax liability. Speak to your qualified accountant or CPA to help you navigate the often tricky waters of tax deductions. The professionals make it their business to be in the know about the latest tax law changes, updates, and deductions. With the right professional on your side, you’ll be able to take full advantage of all the tax breaks you’re legally entitled to.