Not many people venturing into the world of rental property investment know about the related tax benefits this type of asset has to offer.
For many years, the real estate industry has proven to be incredibly lucrative. Investing in property provides many kinds of opportunities to diversify your investment portfolio.
When it comes to rental properties, the one trick to maximizing your rental income that often goes overlooked is taking full advantage of tax benefits.
Taking advantage of your tax benefits has the potential to save you hundreds if not thousands of dollars every year. Best of all, this option doesn’t affect your tenants in any way.
If you’ve been wondering how you can optimize your real estate investment, you are in the right place.
In today’s post, we are going to look at a few tax benefits you can take advantage of as a real estate investor.
4 Tax Benefits of Investing in Real Estate
Owning a rental property means paying thousands of dollars in taxes every year. Luckily, there is a way to lower this tax burden.
Tax Benefit #1: Depreciation
In real estate, depreciation is a process of deducting the costs associated with buying and improving an investment property.
The IRS has specific rules regarding how rental property depreciation works. Your rental property needs to meet certain conditions:
A) You must be the owner of the property in question.
B) You must be using the property to generate income.
C) Your rental property must have a determinable useful life. That is, the property should be something that wears out, gets used up, or loses value from natural disasters.
D) The IRS requires that the property be expected to last more than a year.
When does depreciation start?
Depreciation process counts from the day it became rent-ready. In other words, depreciation starts from the moment your property becomes ready for business.
Tax Benefit #2: Deductions
The number of rental property tax deductions are endless. You can deduct anything from mortgage interest to cleaning services and everything in between.
The IRS allows landlords to take tax deductions for any legitimate expense related to running a rental property. The following are tax deductions that you can take advantage of:
- Legal and professional services: You can deduct fees that you pay to real estate investment advisors, accountants, and attorneys.
- Insurance: You can deduct the premiums you pay for almost any insurance you have taken for your property. For example, flood, theft, and fire insurance.
- Employees and independent contractors: Youcan deduct the wages of anyone you have hired to perform services for your rental property.
- Home office: Landlords can deduct their home office expenses from their taxable income provided they meet certain minimal requirements.
- Travel: Landlords are entitled to a tax deduction for most of the driving they do for their rental activity.
- Repairs: The cost of repairs to a rental property is tax deductible. Good examples of deductible repairs include replacing broken windows, fixing gutters, plastering, fixing leaks, and repainting.
These are the top 6 tax deductions for owners of small residential rental property.
Tax Benefit #3: 1031 Exchange
You can swap your property for another under section 1031 of the Internal Revenue Code. This attracts little or no tax obligation.
However, to be eligible, you need to follow a set of conditions. These include:
- The property you are swapping your property with must be an investment or a commercial property.
- Both properties must be similar. You cannot swap a rental property for a REIT, for example.
- The new property must have a value that is equal to or greater than that of the older one.
- Cash transactions may attract taxation.
- The properties may not be held for personal use, according to the Tax Cuts and Jobs Act.
Tax Benefit #4: Capital Gains
The profits you would gain from selling your investment property is what would be referred to as capital gains. Capital gains can either be short-term – or long term. Tax benefits are what differentiates the two main types of capital gains.
You have probably heard that you should hold your investment property for more than one year before you can sell it. Capital gains are the reason for this. If you sell your property in its first year, it means that you’ll get no tax benefits. You will be expected to pay your taxes as usual.
Conversely, you’ll be eligible for a lower capital gains tax if you sell your property one or more years after you bought it.
Calculating capital gains can be somewhat tricky. The following is an example to help you in this regard:
Figure out your basis in the home. This should include the purchase price plus any improvements you made. Suppose, for example, you bought a rental property for $200,000 in 2010.
As time went by, you renovated the bathroom and put in a new kitchen. You also built an over the garage apartment, put it new wooden floors and updated the countertops. At the end of it all, the total cost of these improvements cost you roughly $100,000.
Consequently, this brought your basis in the home to $300,000 ($200,000 + $100,000).
How much would you pay in capital gains tax after selling the property?
You need to minus the selling costs and real estate agent fees from the cost of the improvements you made to the property.
If the selling costs sum up to $8,000 and you pay your real estate agent $15,000, this means that the sale price will be reduced to $23,000 ($8,000 + $15,000). Therefore, this would leave you with a taxable gain of just $77,000 ($100,000 – $23,000).
These are just a few of many tax benefits available to a landlord. Being knowledgable about them can help you maximize your rental income.