As one of the preferred investing options, real estate offers big tax incentives on everything from rental properties to apartments, vacant land, industrial and commercial buildings, and shopping centers. Ownership of real estate can produce substantial tax savings, including tax sheltering.
One of the biggest real estate tax benefits is deductions. As a property manager, you can deduct expenses for managing, conserving and maintaining the property, and this includes mortgage interest, property taxes, advertising, utilities and insurance, as well as repairs.
The mortgage interest deduction applies to home purchases or newly financed mortgages, home equity lines of credit and home equity loans. Itemize deductions carefully. You can even use your home office by deducting the portion of your home you use for working.
And when you sell your real estate, you'll discover that capital long-term gains are much more favorable for investors — they're taxed at a lower rate than short-term gains.
Not only will you be taxed far less, but you can use previous deductions to lower your taxable amount. The capital gains exclusion can be used more than once, exempting homeowners from paying taxes on substantial profits. But if capital losses exceed capital gains, investors may be allowed to offset other income.
Another tax-saving strategy that's available to real estate investors is the 1031 Exchange of the IRS tax code to sell an asset and use the profit to buy a new one — kicking the can down the road to defer paying taxes until that one is sold — unless you use another 1031 Exchange.
So you take the profit and use it as a down payment on another property. This allows investors to grow net worth without having to fork over money to the IRS. Just follow the strict and complex rules that govern the 1031 Exchange or you'll lose the benefit and have to pay the tax.
Rental property affords investors valid business deductions. Cash flow received from your rental properties is not subject to self-employment tax, and the government offers tax advantages, including significantly lower tax rates for long-term profits.
The cash flow can provide ongoing monthly income. It's stable and far more predictable than most other businesses.
The favorable tax rules available from investing in real estate are a reason why so many fortunes are made in real estate. Another reason is that leveraging real estate investments with mortgage debt can multiply its upside potential.
You can deduct mortgage interest and real estate taxes on rental properties. And you can depreciate the cost of residential buildings, even while they are increasing in value. It lets you have positive cash flow without owing income taxes. A nice benefit, especially if you own several properties.
Good properties can generate the kind of compound tax-deferred growth that investors dream about. Even when you sell the property, your taxable gain can be spread over several years. You don't generally have to pay interest to the government on your deferred gain.
The key thing is to integrate your real estate investments into long-term plans and work closely with qualified financial professionals.