Investing in real estate is a great way to develop wealth and improve your cash flow. In addition to the benefits of receiving monthly rental income, you can also potentially realize some significant tax benefits.
As real estate investor and author Robert Kiyosaki famously said, “It's not how much
money you make, but how much money you keep.” By taking advantage of the diverse tax benefits of investing in commercial real estate, you can keep more of what you make.
The following is a list of the 6 greatest tax advantages of real estate investing:
- Lower Capital Gains – If you make long-term investments in income properties, the profits you make on the sale will fall under long-term capital gains, which are taxed at 0%, 15% or 20% depending on your income bracket. If you are investing for the short term (e.g. flipping or wholesaling), you will not realize any special tax benefit because all of your gains will be taxed at the higher short-term capital gains rate.
It should be noted that if there is a gain on the sale of a building, you may be taxed on recaptured Section 1250 gains. This is due to the depreciation taken over the years on the property that gained in value. These gains could be taxed at a rate of 25% or lower. In other words, the total gain is calculated and the portion of that gain that is attributable to depreciation is taxed at a different rate. - Depreciation – Real estate, like most assets, breaks down over time. For this reason, you are able to claim depreciation on your real property. For residential real estate, the value of your real estate investment property can be depreciated over 27.5 years. For commercial buildings appreciation is realized over 39 years. The beauty of real estate is you can be depreciating the value of the structure while simultaneously realizing an appreciation in the value of your property.
- 1031 Exchanges – As a real estate investor, you can use a tool in the tax code called a “1031 Exchange”. This allows you to defer any profits made on the sale of your real property if you purchase another like property of equal or greater value. The following rules apply to the use of 1031 exchanges:
- The property being replaced and the property or properties bought in its place must have the same or greater value.
- You must identify the property to be purchased within 45 days and close within 180 days.
- The properties must be considered “like kind.” For example, you cannot exchange your property for an investment in a real estate investment trust (REIT.)
- The exchanged property must have been used for productive purposes in business, such as an investment.
- Any cash or property received through the transaction that is not considered “like kind” is considered moot and is subject to taxation.
- The 1031 funds must be kept by an intermediary who will hold onto the funds until the acquisition of the new property is completed.
It should be noted that the Tax Cuts and Jobs Act made changes to 1031 exchanges. 1031 Exchanges can only be used for investment or commercial property and can no longer be used for property owned for personal use.
- Tax Benefits of Refinancing – You can improve your cash flow by refinancing your mortgage on your investment properties. You can do a “term and rate refi” and improve your cash flow by reducing your monthly mortgage payment. You can also do a “cash out refi” where you loan more than the current balance owed and use the additional cash without being taxed on this equity until you sell the property.
- No Income Tax - The IRS does not normally consider real estate investment to be a “business” so you have no “earned income,” which means there is no tax under FICA. The only exception to this is if you own your real estate in a holding company and pay yourself a salary. If you do “materially participate” in the real estate business, you may be able to deduct up to $25,000 of losses. These losses can also be carried forward to future tax periods to offset gains in that period.
- Opportunity Zone Investments – Under the Tax Cuts and Jobs Act of 2017 (TCJA) you can defer capital gains by investing the proceeds into an investment property in a designated “Opportunity Zone.” The great thing about this particular benefit is it doesn’t have to be “like kind,” the proceeds from the sale of another form of investment (e.g. stocks, precious metals trading, etc.) can be deferred by investing in a property in a qualified “opportunity zone.”
- Bonus Depreciation – Under the Tax Cuts and Jobs Act, personal property (sometimes referred to as chattels) such as appliances you provide with your rental units (e.g. oven, microwave, washers, driers,) are eligible for a 100% bonus depreciation, provided the property was put into service after September 27, 2017 through 2022. These items of personal property can be purchased new or used, and are considered to be “qualified purchases” under the bonus depreciation provision
