Are you looking for tax breaks or tax advantages? If so, you should consider investing in real estate! The tax advantages of real estate investing are numerous and can save you a lot of money. In this blog post, we will discuss the tax benefits of owning rental property. We will also provide some tips on how to get the most out of your investment. So, if you’re looking for a way to reduce your tax bill, read on!
Top 5 Tax Advantages of Real Estate Investing
When it comes to tax advantages, investing in real estate can be a great way to save money. The tax benefits of owning a rental property are numerous and can save you a lot of money. Here are the top tax advantages of real estate investing.
1. The Mortgage Interest Deduction
This is one of the most well-known tax advantages of owning a rental property. The mortgage interest deduction allows you to deduct the interest you pay on your mortgage from your taxable income. The mortgage interest deduction can save you a lot of money, especially if you have a high-interest-rate mortgage.
For example, if you have a $500,000 mortgage and your interest rate is five percent, you can deduct $25,000 from your taxable income. That’s a massive saving! If you have a mortgage on more than one rental property, you can remove the interest you pay on all of your mortgages. This can add up to a significant amount of money.
2. Cost Depreciation
Real estate investors can also take advantage of what most people call cost depreciation. It happens when the value of a property decreases over time due to normal wear and tear. The IRS allows investors to deduct this depreciation from their taxes.
Cost depreciation is a huge advantage for real estate investors because it allows them to shelter some of their income from taxes. It can also help investors offset any losses they might have incurred on their investment property.
To calculate cost depreciation, investors need to know the basis of their property. The ground is the property’s original purchase price, plus any improvements made. Once investors have their base, they can depreciate their property throughout the loan term.
Cost depreciation is an excellent way for real estate investors to save money on their taxes. It can also help them offset any losses they might have incurred on their investment property. If you’re considering investing in real estate, take advantage of this tax benefit.
3. Capital Gains
Another advantage real estate investing offers is the opportunity to make money through capital gains. Capital gains are profits you make when you sell an asset for more than you pay. Regarding real estate, capital gains can come from two different sources: the sale of the property itself or the sale of shares in a real estate investment trust (REIT).
You will be taxed on that gain if you sell your property for a profit. However, there are several ways to minimize or even avoid paying taxes on your capital gains:
One way is to take advantage of the step-up in basis rule. This rule allows you to increase the cost basis of your property by the amount of any improvements you made to it during your ownership.
For example, you purchased a property for $100,000 and made $20,000 worth of improvements. If you sold the property for $200,000, your capital gain would only be $80,000. The step-up in basis rule can be a valuable tool for minimizing your taxes when selling a property.
Another way to minimize your taxes is to take advantage of the installment sale method. Doing so allows you to spread the recognition of your capital gain over time. For example, let’s say you sell a property for $200,000 and agree to receive payments of $20,000 per year for ten years.
Under the installment sale method, you would only recognize $20,000 of capital gain in the year you sell the property. In the following nine years, you would acknowledge then $20,000 of capital gain. It can be a helpful way to minimize your taxes if you need to take some time to reinvest your proceeds from the sale.
4. Defer Taxes with Incentive Programs
One of the best ways to defer taxes with real estate investing is to take advantage of incentive programs offered by the government. There are a variety of these programs available, and they can provide significant tax breaks for investors.
Two of the most popular programs are the opportunity zones program and the ten-year exchange program. Both of these programs can help you defer taxes on your real estate investments, and they can provide significant financial benefits.
The opportunity zones program offers tax breaks for investors who invest in certain designated areas. These areas are typically economically distressed, and the tax breaks can help to encourage investment and economic growth.
Meanwhile, the government wants to reward people who reinvest their real estate gains into new ventures, which is why 1031 exchanges exist. The program allows you to exchange them for tax reasons as long as the new property you acquire is of equal or greater worth than the one you sell. The capital gains tax on the sale of the first property can be delayed.
5. Become Self-Employed Without the FICA Tax
If you are an investor in real estate, you can become self-employed without paying the FICA tax. It is a massive advantage because it allows you to defer your taxes until you sell the property. When you sell, you will only pay capital gains taxes on the profit, which is often much lower than your marginal income tax rate.
To take advantage of this, you must structure your business as an S-corporation. It is a simple process that can be done by filing the necessary paperwork with the IRS. Once set up as an S-corp, you can elect to be taxed as a sole proprietor. Doing so will allow you to avoid paying the FICA tax on your income.
Tax Advantages of Real Estate Investing – Summary
If you’re on the fence about real estate investing, hopefully, this post has helped sway you in favor of giving it a try. There are many advantages to investing in real estate, from building wealth and financial security to creating a passive income stream and enjoying tax benefits. There’s no reason not to start real estate investing today with so many potential uses. Are you ready to begin your journey to financial freedom?