Every real estate investor knows that one of the big perks in the biz is found in tax benefits. None of us like paying taxes. They’re inevitable, of course, so why not get the biggest benefits from them you can?
It’ll also be so much easier if you know the taxes you’re on the hook for as a real estate investor – not just how you benefit.
Help yourself by making your next tax return preparations that much simpler.
Taxes Real Estate Investors Might Expect to Pay
Capital Gains
Capital gains taxes are incurred when you sell a property for more than you purchased it. Any profit from the property is subject to capital gains taxes. Of course, rates vary based on whether that asset qualifies as a short-term or long-term capital gain.
Short-term capital gains come from assets you’ve owned for less than a year. On these, you’ll pay your regular income tax rates. Long-term capital gains, though, are more favorable. Properties owned for over a year, then sold, are taxed at rates that can vary from 0% up to 20% based on your income bracket. You won’t have to pay these taxes all the time, but factor them into your exit strategies.
Property Taxes
Property and real estate taxes come from the state or local government in your investment market. These taxes are based on things like the property’s assessed value, land included, as well as property improvements. That said, property taxes are just one more reason why your investment market matters so much. These tax rates can vary greatly depending on the city and state where your properties are located!
Net Investment Income Tax (NIIT)
If you’re a buy-and-hold rental property investor, you’re not likely to have to pay NIIT. It’s for dividends and interest, which are considered investment income. This is a different type of income compared to wages or passive income. With that said, even if you’re receiving investment income, you must surpass a gross income ranging from $125,000 to $250,000, depending on your filing status, before you must pay this tax.
Real Estate Income Tax
Earnings from your rental properties are typically considered passive income, which is taxed at the same rate as regular income. You’ll pay taxes regardless, but you’ll want to know if you meet the IRS’s qualifications for passive income. Unlike earned income, passive income isn’t subject to FICA taxes (Social Security and Medicare). You can often attain a much more favorable effective tax rate through deductions as well.
Tax Benefits Real Estate Investors Might Expect to Receive
Favorable Long-Term Capital Gains Tax Rates
Though real estate investors are going to pay capital gains taxes either way, a buy-and-hold investor will always benefit from the lower long-term capital gains rate. This contrasts with some other real estate investment strategies, like flipping, in which a property is often owned for less than a year. Depending on your filing status and income bracket, you’ll pay either nothing, 15%, or 20%.
Depreciation
The IRS allows property owners to capitalize on the natural “wearing out” of their real estate assets. Depreciation schedules vary based on the type of investment property (multifamily versus single-family, office versus industrial versus retail, etc.).
Depreciation effectively reduces your taxable income. Just be aware that depreciation recapture exists!
Various Deductions
Real estate investors can write off quite a few of their investment-related expenses: property taxes, property insurance, mortgage interest, property management, maintenance and repair (but not improvements), plus certain owner expenses, like travel. Whether passive or earned, the IRS often taxes income at the same rate. The difference is that investors earning passive income can use deductions to reduce their tax liability!
The 1031 Exchange
The 1031 Exchange is a strategy specifically enjoyed by real estate investors. The rules to this strategy are a bit complex (which is why we’ve written more in-depth about it on the blog), but here’s the short explanation: the 1031 Exchange allows real estate investors to trade one like-kind property for another (or several) of greater or equal value. It’s essentially a swap that prevents you from cashing out on a sale – so you defer capital gains taxes.
You’ll definitely want to consult experienced professionals on this one – well before you sell the property you wish to exchange!
For real estate investors, taxes are part of the grand trifecta of benefits, including passive income and appreciation. Make sure you partner with a tax professional or CPA that can help you get the most bang for your investment buck!
Looking to start earning passive income? Connect with one of our Portfolio Advisors today!
