Investing in real estate is a potential way to build long-term wealth, produce cash flow, and create a profitable return when you sell an asset. However, these investments have their own unique set of challenges, one of which includes taxes.
Taxes can impact your investments during the property’s holding period and following the sale; however, there are strategies you can employ to defer or reduce your tax burden. You just need to make the right plan based on your current investments and income needs. Here are some effective tax reduction strategies to consider.
One of the best ways to keep your investments working for you is to leverage as many deductions as possible. Those might include mortgage interest and rental property expenses, for example. Because tax codes change frequently and can be very complex, it’s best to consult with an accountant to figure out which deductions to use.
You can potentially minimize your tax burden by annually deducting property depreciation. According to the IRS, you can use this deduction for the length of your property’s lifespan. Additionally, depreciation applies to many property types, and the IRS is fairly generous when allowing investors to use this deduction.
Increase cost basis
This strategy can be risky but very effective if you use it correctly. Your initial cost basis is the purchase price of the property. With this strategy, you would add to this cost basis by borrowing money for capital improvement projects, borrowing against the property for another purchase, or refinancing your mortgage.
Defer taxes with a 1031 exchange
With a 1031 exchange, you can defer capital gain taxes from the sale of your investment property if you exchange the property for a like-kind investment of greater or equal value. There are specific timing rules and implications involved in a 1031 exchange, so it’s important to consult your adviser before making any decisions.
It’s not about the money you make. It’s about the money you keep. Using these tax reduction strategies can potentially minimize investment property taxes, keeping your hard-earned money working for you.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits.
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital. All real estate investments have the potential to lose value during the life of the investment.