4 Tax Benefits of Real Estate Investing

If you're a real estate investor, it's no secret that taxes are an essential part of your business. But did you know there are actually some tax benefits to owning property? That's right - not only is real estate investing an exciting and profitable way to cultivate wealth, but it can also help you pay less to the IRS.

Do we have your attention yet? Read on to discover four substantial tax benefits you can enjoy if you get into the real estate investing game!

Benefit #1 — You Can Deduct Your Expenses When You Invest In Real Estate

There are many benefits to investing in real estate, but one of the most well-known is the ability to deduct expenses you incur related to your investment properties. The IRS allows individuals to reduce their taxable income by certain expenses when they file their taxes for that year. This means if you own a rental property and have $10,000 worth of deductible expenses during the course of that year, you can use those deductions on your tax return and reduce your taxable income by $10,000!

Examples of some deductible expenses for investment properties include:

• Property taxes
• Property management fees
• Property repairs and improvements 
• Ongoing property maintenance
• Insurance costs
• Advertising expenses 
• Property management fees
• Legal and professional fees
• Business equipment and office space

In some circumstances, you’ll be able to deduct additional expenses as long as they are related to your investment properties or your investment company, if you own one. Because everyone’s situation is different, it always helps to consult with a lawyer or tax professional before claiming any deductions.

Benefit #2 — You Can Deduct Depreciation When You Invest In Income-Producing Buildings

In addition to deducting expenses related to your real estate ventures, you can also deduct the depreciation in value that the building structures will inevitably suffer over time, as long as it is considered an income-producing property.

The first step in deducting depreciation is to calculate the value of the building itself without including the value of the land. You’ll then divide the value of the structure by its “useful life,” which, according to the IRS, is 27.5 years for residential buildings and 39 years for warehouses and other commercial properties. So, for example, if a commercial office building you own and rent out is worth $1 million, you can deduct 1/39th of the value (about $25k) in depreciation each year.

Generally, you can only use losses caused by depreciation to offset passive income and not your total income. So if you earned $200K in salary and have one investment property that lost $5K due to depreciation, you could not use that loss to reduce your taxable income from your salary. However, if you made $10K from another property, the $5K you lost can be deducted for a total of $5K in passive income.

There are three exceptions to this rule:

• If your modified adjusted gross income is less than $100K, you can offset $25K of your non-passive income with depreciation losses.
• You can offset active income with depreciation losses the year you sell the property.
• If you or your spouse is a real estate professional, you can offset non-passive income with depreciation losses.

Benefit #3 — You Pay Capital Gains Taxes Rather Than Income Taxes When You Sell Real Estate

When you earn money by selling a property for more than you initially paid for it, the profits will be subject to capital gains tax rather than income tax. If you own the property for a year or less, the income will be considered a short-term capital gain, which means it will be taxed based on your income-based tax bracket.

Long-term capital gains are where the tax savings can start pouring in. If you owned the property for over a year before selling it, the profit you make would be considered a long-term capital gain. Long-term capital gains are subject to 0% to 20% taxes, with your rate of taxation being based on your income. This rate is lower than their income tax bracket for most people, which can save you thousands in tax dollars.

The long-term capital gains tax rates are as follows:

• 0% for taxable incomes less than $80,000.
• 15% for taxable incomes ranging from $80,000 to $441,450 if you’re single, $496,600 if you’re married filing jointly or a qualifying widow(er), $469,050  if you’re a head of household, or $248,300 if you’re married filing separately.
• 20% to the extent that your taxable income exceeds the limits set for the 15% capital gain rate based on your filing status.

Benefit #4 — You Can Avoid Social Security and FICA Taxes When You Earn Rental Income

Because the IRS considers earnings from rental properties to be passive income rather than active income, you don’t have to pay social security or FICA taxes on your rental income. If you’re employed, you’ll have to hand over 7.65% of each paycheck to FICA, while your employer also pays 7.65%. If you’re self-employed, it’s even worse — FICA will take a whopping 15.3% of your self-employed active income since you’ll have to pay both the employee’s share and the employer’s part. This is called self-employment tax, and it sucks.

Fortunately, Uncle Sam actually cuts us a break for once and considers rental income to be passive. This means it isn’t subject to payroll or self-employment taxes. Paying less in taxes is always great, but on large real estate deals, avoiding that 15.3% self-employment tax can result in significant savings!

Wrapping Things Up

Investing in real estate is a great way to diversify your income and secure yourself some long-term security. We’ve outlined four substantial tax benefits you can enjoy if you get into the game, but there are many more!

If you want to get started in the real estate investment game, we recommend consulting with a business attorney who specializes in real estate investments to make sure you’re taking advantage of all the tax benefits that you can.