Paying taxes is something every real estate investor has to do. There are, of course, many ways of using tax benefits to your advantage, and it's completely legal. When someone says the term "tax benefit," people tend to often think of setting up your LLC offshore or using other methods which are not directly legal.
We wanted to write an article that could briefly explain the most commonly used legal tax benefits in the US and how you can use them to your full advantage.
Here is how You can best plan for tax time:
Deductions
Let’s start with the basics. Deductions are one of the most commonly used ways of using tax benefits for rental properties. These tax write-offs usually include costs associated with mortgage interest, operating expenses, repairs, depreciation, and property tax.
As a property owner, you can deduct most of the necessary expenses for managing and maintaining the property, such as mortgage interest, maintenance, insurance, utilities, and property taxes.
Depreciation
Yet another famous tax break applied to rental properties. What this tax benefit does is that it entails recovering the cost of income-producing property through yearly tax deductions.
There are three factors that determine how much depreciation a real estate investor can deduct each year:
-The depreciation method used
-The value of the property
-The recovery period for the property
There are many depreciation methods out there, but the most commonly used method is a Modified Accelerated Cost Recovery System method. Depreciation is categorized as a net loss on an investment property. The best part is that this applies to the property even if the property produces positive cash flow.
1031 Exchange
Named for Section 1031 of the Internal Revenue System, the 1031 Exchange is a swap of a real estate investment asset for another.
This practically means that you can roll over gains from one real estate investment to another, avoiding taxes until you actually sell the property a year later.
As with everything, there are some regulations to this tax benefit method:
Firstly, the value of the replacement property must be at least equal to the price of the resigned property. Secondly, the exchange property must be "held for productive purposes in business or trade." And lastly, properties in the transaction must be exchanges for an asset, such as a real estate investment trust, commonly known as REIT.
Long-term Capital Gains
The capital gains tax is a form of tax that is levied on the profits realized when an owner sells their assets for more than the original purchase price.
The catch here is that profits are taxed differently, and it primarily depends on how long the asset was held. Assets held under a year and sold at a profit will have short-term capital gains levied in their direction.
However, if you sell an asset for a profit after a year of ownership, the profit made from selling the asset will be taxed as long-term capital gains, which are notably less expensive.
Because of this, many investors often hold to their assets for at least a year before selling them.
Self-directed IRA
Under ordinary circumstances, retirement account holders are penalized for withdrawing their money from their IRA before turning 65. However, the IRS has made some exceptions that you could benefit from.
More specifically, IRA holders may fund a real estate purchase with the funds from their IRAs without being penalized if the profits are returned to the same account from which they came.
How can this be advantageous to you? Most importantly, it gives you the money you need to secure a rental property, and the money returned to the IRA gets the same tax differential treatment that has become synonymous with IRAs.
One thing to keep in mind
Although these are common ways of taking advantage of tax benefits, we want to emphasize that each state has a slightly different perspective on this topic. We advise you to check your local laws to ensure you'll do everything legally and how you're supposed to.
How we help our clients to take advantage of tax benefits associated with real estate
We at Bottom Line Property Management provide owners an online access to all of their statements, copies of bills, an easy-to-understand year-end summary, the 1099 tax form, and much more.
Our philosophy is to provide our clients with all the necessary legal documents while still keeping it simple and easy to understand.
What is Bottom Line Property Management?
We are Bottom Line Property Management, a professional property management company located in Charlotte, NC. What separates us from the rest is that we have 55+ years of combined experience between our leaders in single-family and multi-family residential properties.
We, of course, do not only specialize in tax benefits for our clients since we provide our clients with a plethora of other services.
If you're interested in getting to know more about our company, feel free to contact us. Our team will be more than happy to answer all your questions and hopefully help you with everything.
