Simon CPAs | Accounting and Tax Blog

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.

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.

Buying a home is a significant milestone and a major financial decision. Whether you’re a first-time buyer or looking to move into your next home, you’re bound to have many questions about the process. To help make your journey smoother, we’ve compiled some of the most common buyer questions and provided detailed answers to each. This guide will help you make informed decisions and avoid common pitfalls.

How Much Can I Afford?

This is usually the first question buyers ask, and it’s crucial to figure out before you start your home search. The general rule of thumb is to spend no more than 25-30% of your monthly income on housing. That said, your affordability depends on a number of factors, including your income, debts, credit score, and the amount of your down payment.

To determine exactly what you can afford, consider getting pre-approved for a mortgage. A pre-approval will give you a better idea of what loan amount you’re eligible for and will make you a more attractive buyer to sellers.

What Is a Pre-Approval and Why Do I Need One?

A mortgage pre-approval is a lender’s estimate of how much money they’re willing to lend you based on your financial situation. It’s different from pre-qualification, which is a rough estimate of what you can borrow. Pre-approval involves a more thorough analysis of your credit score, income, and financial history.

Having a pre-approval in hand shows sellers that you’re a serious buyer, and it can give you an edge in a competitive market. It also helps you set a realistic budget before you start looking at homes.

How Much Do I Need for a Down Payment?

The amount needed for a down payment can vary based on the type of mortgage you choose. Traditionally, 20% of the home’s purchase price was the standard down payment. However, there are many loan options today that allow for much lower down payments—some as low as 3%.

For first-time buyers, there are government-backed loans like FHA loans, which require as little as 3.5% down. Keep in mind, though, that putting less than 20% down may require you to pay for private mortgage insurance (PMI), which adds to your monthly costs.

What Are Closing Costs?

Closing costs are the fees associated with finalizing your home purchase. They typically range from 2-5% of the home’s purchase price and can include appraisal fees, title insurance, attorney fees, and loan origination fees.

Some buyers forget to budget for closing costs, which can lead to surprises down the line. Be sure to discuss these costs with your lender early in the process, so you’re prepared when the time comes to close on your home.

How Long Does the Buying Process Take?

The timeline for buying a home can vary widely depending on market conditions, the type of financing you’re using, and the property you’re interested in. On average, it can take about 30-45 days from the time your offer is accepted to close on the home. However, if there are any complications with the appraisal, inspection, or financing, this timeline could be extended.

Should I Get a Home Inspection?

Yes, a home inspection is highly recommended. An inspection gives you a professional evaluation of the home’s condition, identifying any underlying issues that may not be visible during a walk-through. This can include problems with the roof, foundation, plumbing, or electrical systems.

While inspections aren’t always required, skipping one could lead to expensive repairs later on. An inspection provides peace of mind and, if problems are found, can be used as a negotiating tool to lower the price or ask the seller to make repairs.

How Do I Know If a Property Is a Good Investment?

When buying a home, especially if you plan to live in it long-term, you’ll want to consider its potential for appreciation. Look at factors such as the location, school district, and future developments in the area. Homes in desirable neighborhoods tend to hold their value better and may appreciate more quickly over time.

Also, consider the condition of the home. If it’s a fixer-upper, calculate the renovation costs and ensure they fit within your budget. A home that needs too much work might not be the best investment unless you’re prepared for a big project.

In all, buying a home can be a complex process, but asking the right questions will help you navigate it with confidence. From determining how much you can afford to understanding the importance of inspections, being informed can make your home-buying experience smoother and more enjoyable. Remember to consult with a real estate agent and mortgage lender to ensure you have all the information you need to make the best decisions for your financial future.

Sooner or later, you may decide to sell property you inherited from a parent or other loved one. Whether the property is an investment, an antique, land, or something else, the sale may result in a taxable gain or loss. But how that gain or loss is calculated may surprise you.

Your Basis

When you sell property you purchased, you generally figure gain or loss by comparing the amount you receive in the sale transaction with your cost basis (as adjusted for certain items, such as depreciation). Inherited property is treated differently. Instead of cost, your basis in inherited property is generally its fair market value on the date of death (or an alternate valuation date elected by the estate’s executor, generally six months after the date of death).

These basis rules can greatly simplify matters, since old cost information can be difficult, if not impossible, to track down. Perhaps even more important, the ability to substitute a “stepped up” basis for the property’s cost can save you federal income taxes. Why? Because any increase in the property’s value that occurred before the date of death won’t be subject to capital gains tax.

For example: Assume your Uncle Harold left you stock he bought in 1986 for $5,000. At the time of his death, the shares were worth $45,000, and you recently sold them for $48,000. Your basis for purposes of calculating your capital gain is stepped up to $45,000. Because of the step-up, your capital gain on the sale is just $3,000 ($48,000 sale proceeds less $45,000 basis). The $40,000 increase in the value of the shares during your Uncle Harold’s lifetime is not subject to capital gains tax.

What happens if a property’s value on the date of death is less than its original purchase price? Instead of a step-up in basis, the basis must be lowered to the date-of-death value.

Holding Period

Capital gains resulting from the disposition of inherited property automatically qualify for long-term capital gain treatment, regardless of how long you or the decedent owned the property. This presents a potential income tax advantage, since long-term capital gain is taxed at a lower rate than short-term capital gain.

Be cautious if you inherited property from someone who died in 2010 since, depending on the situation, different tax basis rules might apply.

Real estate investing comes with significant tax benefits. Find out how to identify the top tax strategies for maximum benefit and how to use them to your advantage come tax time.

As with all deductions, consult your tax accountant for the most up-to-date on what is/is not allowed regarding tax deductions related to real estate investing.

Self-Employment / FICA Tax

First and most straightforward, you can avoid payroll tax if you own rental property. That’s because the income from your rental property is not considered earned income. In addition to avoiding tax outright, there are numerous deductions available to real estate investors.

Expense Deductions

Real estate expenses directly related to your investment, such as property tax, insurance, mortgage interest, and maintenance or management fees, are deductible. These actual expenses are typical deductions the IRS considers “ordinary and necessary” to sustaining your real estate investment. However, a few deductions to which you may be entitled are often overlooked.

If you spend time traveling to and from your investment property, those miles may be deductible.

You also may be able to deduct non-mortgage interest fees related to your investment property. For example, loan or credit card interest incurred in connection with your investment property are deductible business expenses. Legal and other professional fees directly associated with the investment property are also deductible.

Depreciation

Suppose you have real estate investment property that produces income. In that case, you can deduct depreciation of that property as an expense. The depreciation deduction lowers your taxable income.

The IRS sets the life expectancy of real estate – 27.5 years for residential property and 39 years for commercial property – which determines the deduction to which you are entitled.

Incentive Programs

Some incentive programs make it possible to defer real estate taxes. For example, a 1031 exchange allows real estate investors to avoid paying capital gains taxes when selling an investment property and reinvesting in a replacement property. Investors can reinvest proceeds from the sale of one property into another property. This transaction must occur within a specified time to avoid capital gains taxes (the taxes on the growth of an investment when it is sold).

Suppose your real estate property qualifies as an “opportunity zone,” a low-income or disadvantaged parcel. You may be able to further defer capital gains tax, grow your capital gains, or entirely avoid capital gains.

These perks are time-dependent, which is something your qualified accountant can help you navigate.

Capital Gains

So, what if you sell your real estate investment property? Suppose you can wait until you’ve held the property for at least one year. In that case, you may be able to pay a much lower capital gains tax than if you sold sooner, or you could avoid capital gains altogether. That’s because holding onto a property for more than one year makes it a long-term investment. With that, you will pay a lower capital gains tax rate. If your income is under a certain amount (check with your accountant because these rates tend to change year to year), you may be able to avoid the tax entirely.

Qualified Business Income (QBI) Deduction

More commonly known as the pass-through deduction, this tax break encourages entrepreneurship. This deduction allows certain entities to deduct up to 20 percent of their business income. So, businesses like LLCs, S-corps, and sole proprietorships benefit. You may be wondering how this type of deduction helps real estate investors. If you own rental properties, you technically operate a small business by IRS standards. Therefore, you are entitled to the pass-through deduction. The deduction also benefits real estate investment trust investors (REITs) because REITs are technically considered pass-through entities. The deduction is not scheduled to end until 2025, so there’s still time to take advantage of this deduction.

Deductions like QBI and others on this list, such as depreciation and expense deductions, mean that real estate investment can significantly reduce tax liability. Speak to your qualified accountant or CPA to help you navigate the often tricky waters of tax deductions. The professionals make it their business to be in the know about the latest tax law changes, updates, and deductions. With the right professional on your side, you’ll be able to take full advantage of all the tax breaks you’re legally entitled to.