SS209: Tax Strategies Every Real Estate Investor Should Know

SS209: Tax Strategies Every Real Estate Investor Should Know

One of the significant benefits of investing in real estate is the tax benefits. In this episode, Charles discusses the numerous tax benefits associated with being a real estate investor and how investors can take advantage of them.

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Talking Points:

  • Real estate is an extremely tax-efficient asset class, allowing investors to increase their returns and reduce their taxable income significantly. There are several main tax strategies that all real estate investors should understand.
  • Please note that I am not an accountant, so always consult an accountant before utilizing any tax strategy.
  • Depreciation: Depreciation allows investors to deduct the value of a property over time, even if the property increases in value. Investors can depreciate residential properties over 27.5 years and commercial properties over 39 years. An important factor here is that you cannot depreciate land; you can only make improvements to the land, like the value of the building, driveways, fencing, etc.
  • Cost Segregation: This is an extension of depreciation since investors can identify and reclassify certain personal property assets to accelerate depreciation. For example, if you own an apartment complex, the faucets will not last 27.5 years. They might last 5-10 years. So now, investors can depreciate these items much faster, which lowers the owner’s taxable income.
  • Capital Gains: Investors holding properties for over a year will be taxed at a much lower rate than short-term capital gains or ordinary income rates applicable on properties held for less than a year. Just holding a property for more than a year can dramatically lower the investor’s tax rate on gains.
    • To Learn more about capital gains, check out episode SS62.
  • Mortgage Interest Deduction: Any interest paid on real estate loans for investment properties can be deducted from the property’s rental income.
  • Passive Activity Loss: Rental real estate is commonly considered a passive activity, meaning that investors can only deduct passive losses from their passive income, not their active income (income earned from a job). If the person or spouse is a real estate professional, they can deduct their passive losses against their active income. This is a substantial tax savings. Investors should review the IRS’ rules for being a real estate professional and see if they qualify.
  • Installment Sales: An installment sale is when a property owner provides seller financing on a property to a purchaser and spreads the receipt of the sale proceeds over time. The goal is to pay less taxes by keeping the seller in a lower tax bracket. The seller will then receive a portion of the gain yearly and only pay taxes on the gain received during the year. Using this strategy, the seller can manage their tax exposure. If you are a buyer, this is an excellent suggestion to owners who have owned their property for many years. You can craft a deal to purchase the property in installments to avoid a traditional mortgage while the seller can lower their tax liability. It’s a win-win.
  • 1031 Exchange: If you are selling a property and plan to purchase a larger property with the proceeds, a 1031 exchange is a great option. The tax payment on the gain is deferred by reinvesting the initial property’s entire proceeds in a new property. This is a very powerful strategy for investors looking to purchase a larger property without paying taxes on the gain from their current property. And investors can continually do this.
  • Self-Directed IRA Investing: Passive real estate investors can defer or eliminate their taxes on rental income and gains by utilizing a self-directed traditional IRA or a self-directed Roth IRA. However, there are a couple of essential things to be aware of. First, you must be passive in the deal, not an active owner. Secondly, if the properties are financed by debt, you may have to pay UBTI or Unrelated Business Taxable Income. Please speak to your accountant before you open a self-directed IRA or invest with it. Because there are strict rules that you need to follow.

 

Understanding and implementing these strategies will help decrease your tax bill, and some savvy investors may also share these tax methods with potential property sellers to craft win-win deals for both parties.

Transcript:

Charles :
Did you know that most real estate investors miss out on thousands of dollars in savings simply because they don’t know the right tax strategies? Over the years, I’ve spent countless hours talking to the top real estate tax advisors that dive deep into the Iris’s rules to uncover the most powerful tax saving tactics for real estate investors.

Charles :
Welcome to Strategy Saturday! I’m Charles Carillo, and today we’re diving to the tax strategies that every real estate investor should know. Whether you’re buying your first rental or building a real estate portfolio, these strategies could help you save thousands so you can keep more of your own profits. Now, stick around because by the end of this episode, you’ll understand these strategies and know how to start implementing them to maximize your returns and minimize your tax liability. So let’s get started. Real estate is an extremely tax efficient asset class, allowing investors to significantly increase their returns and reduce their taxable income.

Charles :
There are several main tax strategies that all real estate investors should understand. But before we get started, please note that I am not an accountant. So always consult an accountant before utilizing any tax strategy. Number one is depreciation. Depreciation allows you to deduct the value of a property over time, even if the property increases in value. Investors can depreciate residential properties over 27 and a half years and commercial properties over 39 years. This is called straight line depreciation. An important factor here is that you cannot depreciate land. You can only depreciate the improvements to the land, like the value of a buildings, uh, driveways, fencing, et cetera. Number two is cost segregation. This is an extension of depreciation since investors can identify and reclassify certain personal property assets to accelerate their depreciation. For example, if you own an apartment complex, the faucets will not last 27 and a half years.

Charles :
They might last five to 10 years. So now investors can depreciate these items much faster, which lowers the owner’s taxable income. Number three is capital gains. Investors holding properties for over a year will be taxed at a much lower rate than short-term capital gains or ordinary income rates applicable on properties held for less than a year. So just holding a property for more than a year can dramatically lower the investors’ tax rate on gains. And to learn more about capital gains, you can check on episode SS 62. That’s SS 62. Number four is mortgage interest deduction. So any interest paid on real estate loans for investment properties can be deducted from the property’s rental income. Number five is passive activity loss. So rental real estate is commonly considered a passive activity by the IRS, meaning that rental income is considered passive income by the IRS’s standards and that investors can only deduct passive losses from their passive income, not their active income, active income being income earned from a job.

Charles :
Now, if the person or the spouse is a real estate professional, they can, uh, now deduct their passive losses against their active income. This is a substantial tax savings. Investors should review the Iris’s rules for being a real estate professional and see if they qualify for, um, this, uh, ability of, uh, passive losses. Number six is installment sale. So an installment sale is when a property owner provides a seller financing on, on a property to a purchaser and spreads the receipt of the sale pro proceeds over time. And the goal is to pay less taxes by keeping the seller in a lower tax bracket as they’re receiving those sale proceeds. Now, the seller will then receive a portion of the gain yearly and only pay taxes on the gain received during that year. Using the strategy, the seller can manage their tax exposure. And if you’re a buyer, this is an excellent suggestion to owners to have, uh, that have owned the property for many years.

Charles :
You know, 10, 15 years is probably best when they can utilize this ’cause it’s probably paid off. And as a buyer, you can craft a deal to purchase the property and installments to avoid a traditional mortgage while the seller can lower their tax liability. So it’s a super win-win situation for both parties. Number seven is the 10 31 exchange. So if you’re selling a property and plan to purchase a larger property with the proceeds, a 10 31 exchange is a great option that you should consider. Now, the tax payment on the gain is deferred by reinvesting the initial property’s entire proceeds in a new property. And this is a very powerful strategy for real estate investors looking to purchase a larger property without paying taxes on gains from their current property. And investors can continually do this. So you can 10 31, 10 31, 10 31, and um, at that point, you, you can pay taxes at the end of it or if you pass away, it can now get step up in basis for your heirs.

Charles :
Very, very powerful. Number eight is self-directed. IRA investing. So passive real estate investors can defer or eliminate their taxes on rental income and gains by utilizing a self-directed traditional IRA or a self-directed Roth IRA. However, there are a couple of essential things to be aware of. First, you must be passive in the deal, not an active owner. And there’s all these different rules about, you know, you can’t have it for like, you know, you can’t buy a property and then rent it out to a family member. And there’s a number of different rules that you really have to review. This is just a quick over summary overview summary. Secondly, if the properties are financed by debt, you may have to pay UBTI or unrelated business taxable income. So please speak to your accountant before you open a self-directed IRA or invest with one. Um, because these are very strict rules that you need to follow to do this understanding, implementing these strategies will help decrease your tax bill.

Charles :
And some savvy investors may also share these tax messages with potential property sellers to craft win-win deals for both parties. So I hope you enjoyed. Please remember to rate, review, subscribe, submit comments, substantial show topics at globalinvestorspodcast.com. If you are interested in actively investing in real estate, please check out our courses and mentoring programs at syndicationsuperstars.com. That is syndication superstars.com. Look forward to two more episodes next week. See you then.

Charles :
Have you always wanted to invest in real estate, but didn’t have the time, didn’t know where to find the deals, couldn’t get the funding and didn’t want tenants calling you. Since 2006, I’ve been buying income producing properties and great locations that provide us with consistent passive income. While we wait for appreciation in the future and take advantage of tax laws while we’re waiting and unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out to investwithharborside.com. If you like the idea of investing real estate, if you like the idea of passive income partner with us at investwithharborside.com, that’s investwithharborside.com.

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure subscription documentation. At our subject to all applicable laws, please consult an appropriate tax, legal, real estate, financial, or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of syndication superstars, LLC exclusively.

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