Real Estate

If you’re a real estate investor, saving money on your taxes can be just as crucial to your bottom line as the deals you make daily. While numerous tax strategies that you can implement to save on taxes exist, a few of them are more valuable than others. Here, we discuss four of the top tips for saving money on real estate taxes.

1. The 1031 Exchange

A 1031 exchange is a way for real estate investors to defer capital gains taxes when selling an investment property by reinvesting their profits in a replacement property. This is also called a like-kind exchange. It is essentially a swap of one investment property for another. “Like-kind” refers to the fact that the properties in the exchange must be similar, and the exchange property must be of equal or greater value than the property sold. Because it is rare for an even property swap to occur between parties, the most common type of exchange is the delayed “forward” exchange. In this case, the sold property funds are sent to a qualified intermediary. The intermediary holds the transaction funds from the sale of the first property until they are transferred to the seller of a replacement property.

2. The Business Tax Deduction

The expenses that you incur from owning a property are deductions that can be advantageous for part- and full-time real estate investors. Qualifying expenses include mortgage interest, insurance, fuel used for travel to and from the property, phone, internet, home office, etc. If some expenses are shared for business and personal use (such as your phone or internet), be sure to divide the expenses accordingly and only deduct what is used for your business.

Also, note that the allowable expense deductions must be ordinary (common in your field) and necessary (aid you in conducting business).

3. Long-Term Capital Gains

When selling a property for profit, a capital gains tax can be assessed. If you sell a property in the short term (within one year of purchasing it), the profit you make from the sale is considered income. This can put you into a higher tax bracket and increase taxes that you owe significantly (the short-term capital gains tax can be as high as 35 percent!). However, you can avoid a large tax bill due to selling an investment property if you can hold onto the property until after the first anniversary of purchasing it. That’s because the long-term capital gains tax rate is lower than the rate on income tax that applies for short-term gains (the long-term capital gains tax usually tops out at 15 percent, depending on tax filing status and income).

4. Depreciation Losses

Depreciation, the gradual loss of an asset’s value, allows you to take a tax break for property wear and tear over time. By deducting depreciation of real estate investments on your taxes as an expense, you lower your taxable income. This could potentially lower your tax liability.

According to the IRS, the expected life of a parcel is 27.5 years for residential properties and 39 years for commercial properties. The depreciation deduction for the entire expected life of a parcel can be taken. For example, if you buy a house valued at $300,000 (value of the structure, not the land it sits on) as an investment property to rent, you divide that value by 27.5 years, which gives you $10,909. That is the amount you can deduct in depreciation each year on your taxes.

Be aware that if you ever sell the property, you will have to pay the standard income tax rate on the depreciation you claimed (Note: this is “depreciation recapture” and can be avoided with strategies like a 1031 exchange discussed in point 1.) You can also possibly depreciate improvements you make to investment properties like replacing the roof or similar significant upgrades.

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Speak to your accountant about these money-saving strategies, as well as other potential ways to keep more profit in your pocket when conducting your real estate investment business.

A unique set of tax responsibilities are associated with rental properties. If you own rental property, read on to learn more about your tax obligations related to rental income.

What is Rental Income?

Rental income is any payment you receive for the use or occupation of your property. While rental income is taxable, that does not mean that every penny you collect in rent is taxable. You can reduce the amount of your rental income by deducting certain expenses associated with your rental property, such as maintenance expenses. Let’s look at some specific deductions related to rental income.

Am I Eligible for Deductions Related to Rental Income that I Earn?

Per the IRS, expenses of renting property can be deducted from your gross rental income. For example, costs related to servicing, managing, and maintaining the rental property are generally deductible. Those expenses include cleaning service, homeowner association dues, condo fees, management fees, pest control, lawn maintenance, insurance premiums, property taxes, and even advertising the property.

If your rental property is vacant, the expenses you incur for maintaining it are still deductible. As long as the expenditures you deduct are not excessive and remain in routine upkeep, they are acceptable.

You can even deduct travel expenses you incur when going to and from your rental property. Just be sure your travels are expressly related to checking on the property and/or conducting business or tasks related to the property’s maintenance and upkeep. Any personal costs associated with such a trip are not deductible and must be separated from the rental property-related travel expenses.

Rental expenses are usually deducted in the year you pay them.

How is Rental Income Reported to the IRS?

Rental income is reported on your tax return for the year you receive it, in other words, when the funds are credited to your bank account. This is referred to as “constructively receiving income” by the IRS and is detailed in IRS Publication 538.

There are several unique situations that you may encounter as a landlord. For example, advance rent, security deposits, tenant-paid expenses, services in place of rent, and personal use of a rental property. Let’s look briefly at these now.

Advance Rent

Advance rent is money received before it is due or before the rental period is covered. This income must be included in your rental income in the year you receive it, regardless of when it is due, or the period it covers.

Security Deposits

Security deposits are not included in rental income if that money will be returned to the tenant when their rental period ends. However, suppose you retain part or all of the security deposit. In that case, if the tenant does not meet the lease agreement terms, that amount must be included in your rental income for that year.

Expenses Paid by Tenant

Suppose a tenant pays for rental property-associated expenses. In that case, that is considered rental income, and you must claim it as such in the year it is received. Those can be deducted if that amount includes any deductible rental property expenses. The IRS provides more detailed information on this topic in IRS Publication 527.

Services instead of Rent

Suppose you receive services instead of money for rent. In that case, the fair market value of those services must be included in your rental income. Suppose the services are provided at a mutually agreed upon exchange rate. In that case, that amount is the fair market value of the services.

Personal Use of Rental Property

Suppose you use your rental property (i.e., a vacation home, condo, etc.). In that case, your expenses must be divided between personal and rental use. The IRS provides information on how to do this in IRS Publication 527.

What Else Do I Need to Know about Rental Income?

There are a few other tips you need to know about how to handle rental income taxes. For example, if you make general repairs to your rental property, those are deducted in the year you make them. However, suppose you make improvements to your rental property, such as adding on or making other significant changes to improve your property. In that case, those improvements are capitalized and depreciated over time per the IRS depreciation tables.

The best way to determine precisely what to do regarding rental income taxes is to rely on the services of a qualified accountant or CPA to guide you through the ever-changing tax laws. That way, you’re sure to take advantage of every deduction due to you within the confines of the law.

If you’re the co-owner of a property, whether it is joint tenancy as in marriage or tenancy in common between real estate partners, some tips can make life easier for you come tax time. Read on to learn more about how to handle co-ownership of property.

Types of Co-Ownership

There are several types of co-ownership of property. Below, three types are explained.

Joint Tenancy

Joint tenancy is a term that describes and defines ownership interests and rights between two or more property co-owners. In joint tenancy, the two (or more) property owners have equal rights and responsibilities of the real estate. If the joint tenancy is between two people, each individual has 50 percent ownership.

Joint tenancy can apply to:

• Personal property
• Bank and brokerage accounts
• Business ownership
• Real estate investment property

In joint tenancy, the right of survivorship exists. This means that if one of the co-owners dies, even if they have heirs, those heirs will not inherit their shares of the property. Instead, the other joint tenant receives that share of the property. This is the typical type of co-ownership between a married couple; however, joint tenancy can be established between unmarried individuals, family members, friends, or investment partners.

Tax liability and deductions are generally split 50-50 (or some other equal division if there are more than two co-owners).

Tenancy in Common

The main difference between joint tenancy and tenancy in common is that where joint tenancy provides equal ownership between all co-owners, tenancy in common allows co-owners to own different percentages of the property. Furthermore, ownership can be acquired after the original owner purchased the property. The owners have rights only to their percentage of the property; therefore, if one owner dies, their share passes to their heirs, not to the other owner(s) as it would in joint tenancy.

When real estate taxes are assessed on the property, all owners listed on the deed are legally responsible for the total amount of the tax. How those taxes are collected from each owner and paid is up to them. For example, if there are three owners in a tenancy in common agreement, they may decide to split the unequally. In situations where there is a joint mortgage, the mortgage interest deduction can be divided between owners by including a mortgage interest statement when filing taxes.

Tenants in common should always seek an ownership agreement in writing to protect each owner’s interests in the property and to delineate how taxes will be paid and deductions will be claimed.

Tenancy by Entirety

Tenancy by entirety is only for married couples and is only an option in 25 states and Washington, D.C. It comes with survivorship, like joint tenancy, but there are differences.

Recall that in a joint tenancy situation, each owner has an equal share of the property with equal rights and responsibilities. For a married couple, each individual owns 50 percent of the property.

However, in tenancy by entirety, the individuals are viewed as one person. Each person owns 100 percent of the property. Any action regarding the property, i.e., selling the property, requires mutual consent.

The primary benefit of tenancy by entirety is that the property cannot be used to satisfy the debts of one party.

The primary disadvantage of tenancy by entirety is that it guarantees the property goes into probate once the second spouse dies. This could be impactful for any heirs.

When sharing property ownership or estate planning, always rely on a qualified accountant or CPA to guide you on the best option for your unique situation.

Are you debating on whether or not to buy a home? There are some substantial benefits of being a property owner that goes beyond not having a landlord. Here, seven of those benefits are revealed.

There are some standard deductions involved in home ownership that apply to all homeowners. Let’s look at the top four:

1. You can deduct the interest you pay on your mortgage.

According to the IRS, mortgage interest on the first $750,000 ($375,000 if married filing separately) of debt can be deducted. Higher limits ($1 million ($500,000 if married filing separately)) apply if you deduct mortgage interest from debt incurred before December 16, 2017. In most cases, all home mortgage interest can be deducted. How much you can deduct depends on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds. IRS Publication 936 details home mortgage interest deductions.

2. You can deduct mortgage insurance.

Homeowners who pay mortgage insurance as part of their monthly mortgage payment may qualify to deduct that expense from their taxable income, depending on their income.

Typically, when less than 20 percent of the loan amount is paid down on a home purchase, borrowers must get private mortgage insurance (PMI). Mortgage insurance protects the lender if the homeowner cannot make their mortgage payments and defaults on their loan.

Homeowners with an adjusted gross income of up to $100,000 (or up to $50,000 if married and filing separately) can deduct their mortgage insurance premiums. Above those amounts, the deduction phases out. Those with an adjusted gross income over $109,000 (or $54,000 if married and filing separately) are ineligible for the deduction.

3. You can deduct state and local taxes.

If homeowners itemize them on their federal income tax return, they can take the SALT (State and Local Tax) deduction. If a homeowner pays taxes through escrow, that amount is on form 1098. Homeowners can deduct up to $10,000 of their state and local property taxes and state income or sales taxes. Income and sales taxes cannot be deducted, so you can combine property and sales taxes OR property and income taxes. A qualified tax accountant can help you determine which is best for you.

4. You can get a residential energy credit.

There are benefits for homeowners who make their home energy efficient. According to the IRS, qualified energy efficiency improvements include the following qualifying products:

• Energy-efficient exterior windows, doors, and skylights
• Roofs (metal and asphalt) and roof products
• Insulation

Residential energy property expenditures include the following qualifying products:

• Energy-efficient heating and air conditioning systems
• Water heaters (natural gas, propane, or oil)
• Biomass stoves (qualified biomass fuel property expenditures paid or incurred in taxable years beginning after December 31, 2020, are now part of the residential energy efficient property credit for alternative energy equipment.)

Next, there are a few other deductions that apply to some homeowners:

5. You can deduct your home office.

If you work from home like many do these days, or if you have a home-based business, you may be eligible for this deduction. A dedicated part of your home must be used exclusively and regularly for your job or business to qualify for this deduction. The home must be the primary location of your work or business.

Homeowners can determine the percentage of their home used for business or take a $5 deduction per square foot (up to 300 square feet) used for your work.

6. You can deduct improvements to your home if they are medically necessary.

The medical expenses tax deduction allows homeowners who must make medically necessary home improvements to deduct a portion of those expenses. You must itemize the expenses, and you can only deduct expenses over 7.5 percent of your adjusted gross income.

Medically necessary expenses include:

• Widening doorways or hallways
• Installing ramps or lifts
• Adding railings
• Lowering cabinets and vanities

7. When you sell your home, you can get some profits tax-free.

If homeowners decide to sell their home and have lived in it for two of the last five years, they can save big via the capital gains tax exclusion. That exclusion means a homeowner does not have to pay taxes on the first $250,000 (single) or $500,00 (married) profit from the sale of their home. This exemption is more beneficial than the capital gains deduction. Keep accurate records and track improvements and maintenance expenses, as these can impact capital gains when you sell your home.

Another thing to know about taking certain deductions, like the mortgage interest and insurance deductions, as well as the SALT deduction, is that deductions must be itemized on your federal tax return. These deductions are not applicable if you take the standard deduction.

To keep track of all these possible deductions and more that homeowners may benefit from, get in touch with your local accountant or CPA so that you can stay up to date on changing deductions, benefits, and more for homeowners.

Investing in real estate can be a lucrative endeavor, offering the potential for long-term financial stability and wealth accumulation. However, knowing when to expand your portfolio and acquire additional properties requires careful consideration and assessment of various factors. In this article, we’ll explore the signs that indicate you’re ready to take the leap into investing in additional properties.

1. Strong Financial Position

The first and most critical sign that you’re ready to invest in additional properties is a strong financial foundation. This includes having sufficient savings for a down payment, a stable source of income to cover mortgage payments and property expenses, and a healthy credit score to qualify for financing. Before acquiring additional properties, ensure that you have a clear understanding of your financial situation and are prepared for the financial responsibilities of property ownership.

2. Positive Cash Flow from Existing Properties

If you already own rental properties, positive cash flow is a key indicator that you’re ready to expand your portfolio. Positive cash flow means that the rental income from your properties exceeds the expenses associated with ownership, such as mortgage payments, property taxes, insurance, and maintenance costs. Having a consistent stream of income from your existing properties can provide the financial stability needed to pursue additional investments.

3. Diversification Strategy

Diversification is essential in real estate investing to mitigate risk and maximize returns. If you have a well-diversified portfolio that includes a mix of property types (e.g., residential, commercial, multifamily) and geographic locations, you may be ready to add more properties to your portfolio. Diversification helps spread risk across different assets and markets, reducing the impact of adverse events on your overall investment performance.

4. Knowledge and Experience

Investing in real estate requires a certain level of knowledge and experience to navigate the complexities of the market effectively. If you have successfully managed and operated rental properties in the past, you may be ready to take on the challenge of acquiring additional properties. However, if you’re new to real estate investing, consider seeking guidance from experienced investors, attending educational seminars, or partnering with a mentor to enhance your knowledge and skills.

5. Long-Term Investment Goals

Before investing in additional properties, it’s essential to have a clear understanding of your long-term investment goals and objectives. Are you looking to generate passive income, build wealth through property appreciation, or diversify your investment portfolio? Understanding your goals will help guide your investment decisions and determine the types of properties that align with your objectives.

6. Market Analysis and Research

Conducting thorough market analysis and research is crucial before investing in additional properties. Evaluate market trends, supply and demand dynamics, rental rates, vacancy rates, and economic indicators to identify promising investment opportunities. Look for markets with strong job growth, population growth, and economic stability, as these factors can positively impact property values and rental demand.

7. Risk Assessment and Mitigation

Real estate investing inherently involves risks, including market fluctuations, tenant turnover, unexpected repairs, and economic downturns. Before acquiring additional properties, assess the potential risks and develop strategies to mitigate them effectively. This may include maintaining adequate cash reserves, securing insurance coverage, conducting thorough tenant screening, and implementing property management best practices.

Conclusion

Investing in additional properties can be a rewarding venture for those who are well-prepared and strategic in their approach. By assessing your financial position, evaluating market opportunities, and understanding your long-term goals, you can determine whether you’re ready to expand your real estate portfolio. Remember to conduct thorough due diligence, seek professional advice when necessary, and approach investing with a long-term perspective for success in the dynamic world of real estate.