Business Blog

Tax Advantages of Investing in Real Estate

Real Estate can be a particularly prudent long term investment, and one reason why is that it offers big tax incentives.  Everything from residential rental properties, to apartment complexes, vacation homes, vacant land, industrial and commercial buildings, and shopping centers can be treated as a real estate investment. Ownership of real estate can produce substantial tax advantages.

One of the biggest real estate tax benefits are the allowable deductions.  The 1040 schedule E allows you to deduct expenses in a similar way that you would for a business that you own. 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.  You can also deduct depreciation of your real estate as an expense to offset rental income each year.

The mortgage that you pay on rental real estate is not an itemized deduction.  Instead it becomes an allowable business expense that offsets income that you earn.  If you are an active manager of the property, there is currently a tax provision that allows you to deduct up to $25,000 of losses.  If you are not an active manager, then losses may only be recognized to offset rental income.

And when you sell your real estate, you’ll discover that capital long-term gains are much more favorable for investors — they’re currently taxed at the lower capital gains rates of 10, 15, or 20% depending on your adjusted gross income.  Any property sold in less than one year will be taxed as a short term capital gain.  Do keep in mind that any income that you earn from renting out the property each year is taxable at your marginal income tax rate.

Remember that if you sell your primary residence and recognize a capital gain, you are allowed to reduce that amount by either $250,000 if single or $500,000 if married filing joint.  This only applies to any residence which was your primary residence 2 of the past 5 years.

Another tax-saving strategy that’s available to real estate investors is the infamous 1031 Exchange of Like Kind Property. The IRS tax code allows you to sell an asset and use the profit to buy a new asset of the same type without paying tax on the capital gains earnings.  The process essentially defers the tax bill, since your basis for the original property carries over.  You can 1031 exchange over an over again with the same capital to avoid paying tax on it indefinitely.

So now you can take the profit from your last real estate venture 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 make sure follow the strict and complex set of rules that govern the 1031 Exchange or you’ll lose the benefit and have to pay the tax.

Another large benefit to consider is that the earnings from investment real estate are not subject to self-employment tax, which any business owner can tell you is significant.

The favorable tax rules available from investing in real estate are one reason why so many fortunes are made in real estate. Another reason is that leveraging real estate investments with mortgage debt secured by the property can multiply your return on invested capital.

Good properties can generate the kind of compound tax-deferred growth that investors dream about. Even when you sell the property, you can defer capital gains by reinvesting the money into another property.

If you decide to invest in real estate, we recommend that you consult a professional about the financial and tax implications.

Pencil icon
Pen icon

Related Blog Posts

6 Tips for New Entrepreneurs

What Are NFTs?

DHS Adding 22,000 to H-2B Program

Stambaugh Has Your Back. 

Don’t let financial uncertainty hold you back.