Direct real estate investments have a few tax advantages that passive real estate investing doesn’t. Of course, direct real estate means more work. Passive real estate investing is just that, passive and mainly hands-off, except for some managing of the investment. Passive investors don’t have to deal with tenants or repair buildings.
However, for the work, the tax advantages can be fairly large in direct real estate. Let’s take a look at what these tax advantages are.
When we’re talking about tax advantages, we’re talking about direct real estate rather than passive. As outlined in the introduction, passive real estate investing doesn’t offer the same number of tax benefits as direct real estate. Passive real estate investing includes real estate stocks, real estate investment trusts (REITs), Delaware Statutory Trusts, and basically any real estate investment that is considered a security. If you aren’t getting your hands dirty with day-to-day operations in the investment, then it is probably passive.
TICs (i.e., Tenants-in-Common) are direct real estate unless the TIC has been securitized. Two or more people involved in a TIC who handle building maintenance, finances, and deal with tenants are in a direct real estate investment. No one else is managing the investment except them. The investment is not passive for either investor because it would not exist without their involvement.
Investors in a TIC that a sponsor manages are most likely utilizing a security. Most investments that have a sponsor are securities. The investors or LPs (i.e., limited partners) are not directly involved in the day-to-day operations of the security. They only funded the project.
As outlined above, we’ll focus on direct real estate, which owning rental property falls under.
The first set of tax advantages is the many operational expenses. These directly offset profit and thus lower taxable income. Operational expenses include day-to-day expenses involved in operating the business.
Next is CapEx (i.e., capital expenses), which are larger expenses that are generally deducted over several years. These expenses involve large purchases such as a roof, air conditioning, and parking lot replacement. Because these assets have a multi-year life span, they are written off over multiple years.
Rental property investors can also deduct their mortgage interest as an expense. Like other expenses, this reduces taxable income.
We finally reached one of the most popular and tax-advantaged expenses a rental property investor can take — depreciation. Depreciation is a non-cash flow expense. It doesn’t require any money from the investor’s bank account. Like CapEx, depreciation is taken over a period of years.
So yes — there are tax advantages to owning rental property. Many real estate investors spend lots of time focusing on these tax advantages to get the most out of them. It’s best to work with a tax professional to ensure your rental property is maximizing its real estate tax benefits.