The Tax Benefits Of Private Real Estate

Posted by Amr Tenney on Dec 25, 2020


Investing in real estate is widely accepted as one of the best ways to grow wealth. Real estate is a consistent performer, and generating passive income is frequently cited as a key component of the strategy employed by successful investors. Real estate investments typically offer more options than the purchase of stocks or bonds. Once you invest in those offerings, you have limited or no control over your stake's success. With real estate, you can rent a property or sell it. You can remodel it to increase the value or refinance it if conditions allow. A widely accepted though possibly apocryphal homily (credited to Andrew Carnegie among others) maintains that 90% of the world’s millionaires became wealthy through real estate investments.

Making a modest initial outlay can often be leveraged into a more significant purchase. Using mortgages to expand your portfolio may allow you the opportunity to enjoy the appreciation in an advancing market while you use the cash flow being generated to cover the expenses. Real estate values and rents are expected to increase over time, which means that your cash flow will improve if rent goes up, and when you decide to sell, you may earn a profit.

Meanwhile, you can deduct the typical costs of owning the investment property. Depreciation is one of the deductions for an investment property. Keep in mind that the intent of depreciation from a tax perspective is to recognize the allocation of an asset's useful life span. That means that an investor can depreciate improvements (such as buildings) but not land since land does not lose its productivity. For residential real estate, the investor can take a straight-line depreciation of the asset over 27.5 years. If you buy a single-family residence for $750,000, and $100,000 is attributed to the land, then you can claim a depreciation deduction of $26,636 annually ($650,000/27.5).

Keep in mind that if you are paying a mortgage on this property, you can also deduct the mortgage interest you pay. The property taxes are deductible, as are operating expenses such as advertising, maintenance, insurance, and utilities (if you pay them on behalf of the tenant.) You may deduct the cost of repairs you make to a residential rental property, but not improvements. You would recover the value of property improvements through depreciation.

For most owners of residential rentals, the Tax Cuts and Jobs Act created a new tax deduction. Suppose your rental qualifies as a business for tax purposes (most do, but always consult your tax advisor). In that case, you may be able to deduct 20% of your net rental income, on top of all the other rental property deductions. This benefit is referred to as the "pass-through" deduction and is scheduled to remain in effect until January of 2026. The TCJA amended two additional tax code provisions related to rental business deductions. Section 179, which deals with personal property used in a rental business (like appliance and furniture), got an expanded definition and allowance. Also, the depreciation of personal property used in the rental activity benefits from an expanded application and "bonus" depreciation period.

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.

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