Tax Day is upon us! If you haven’t started working on filing for 2022, you may officially be procrastinating. We get it – taxes are never fun, even when you have a CPA doing the heavy lifting for you. With that said, you can make tax season a little less painful by leveraging your real estate investments to reduce your tax liability!
Whether you learn a new trick for this filing season or one to implement in the next, here are some great tax strategies to help investors hold on to their wealth.
Smart Tax Strategies for Real Estate Investors to Remember
1. Utilize a Self-Directed IRA
An SDIRA opens up the ability to invest in real estate, something that conventional IRAs don’t permit. The property is technically held by your account as a separate entity – not by you yourself. Because of this, income earned goes right back into the IRA and is used for the management, maintenance, and acquisition of properties, along with any other investments you wish to make. The big thing, though, is that you don’t pay taxes on any of this income. At least, not until you choose to withdraw funds.
Just make sure you do it once you’re 59 ½ or older to avoid penalties!
2. Leverage a 1031 Exchange
1031 exchanges may sound complex, but they’re really quite simple in concept. In effect, real estate investors designate their property for an exchange and, making sure that they never touch money from the sale of the property through a qualified intermediary (QI), immediately use that money to acquire another property. It makes function like a trade; allowing investors to refine and grow their portfolio minus capital gains taxes.
There are many rules to perform a successful 1031 Exchange, though, so make sure to consult your advisor well in advance.
3. Buy and Hold
Just by merit of being a buy-and-hold real estate investor, you pay less than flippers. When you hold a property for at least a year, you pay long-term capital gains rather than short-term capital gains taxes, meaning you get a much better rate! Generally speaking, not only is buy-and-hold investing less risky than more active investment strategies, but it provides bigger tax advantages.
4. Track Deductible Expenses
While investors can just take a standard deduction rather than itemizing, you want to keep close track of all investment-related expenses throughout the year. You wouldn’t want to take the standard deduction if your deductible expenses were greater. So, what can you deduct? Consult your CPA to make sure you’ve taken advantage of all available deductions, but here are the most common line items:
- Property Management Fees
- Insurance
- Maintenance Costs
- Mortgage Interest
- Home Office Expenses
- Travel Expenses
- Advertising Costs
- Closing Costs
Track these throughout the year and keep receipts and invoices. It will make claiming deductions much easier.
5. Leverage Existing Equity
Over time, investors benefit from appreciation and increasing equity. Because rental income gradually pays off the mortgage balance, you effectively only pay for your initial down payment and closing costs. Leverage is a powerful thing! Once you maximize your equity by paying off the property, you have a few options. You can keep holding, earning pure rental income. You can sell, knowing that you receive the maximum value for the property, debt-free.
You can also leverage your equity to acquire more properties. This prevents you from needing to sell to raise capital to invest and allows you to buy real estate without paying taxes on the cash you needed to get there.
6. Never Sell
Although equity and appreciation are some of the great advantages of real estate investing, no one said you had to be the one to tap into them. If you, over time, have totally paid off a property via rental income and are content to earn passive wealth, why sell?
Here’s a strategy that benefits your heirs: let them pry your properties out of your cold, dead hands. Literally. When you die holding properties, the heirs that inherit them will not be on the hook for capital gains taxes. This gives the next generation a big advantage, as they can move straight into earning passive income and significantly boosting their net worth. If building generational wealth is your goal, hold on!
Plus, you’ll never have to pay capital gains on something you never sell.
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