5 Tax Deductions for Real Estate Investors
Tax season is always around the corner. As you buy and sell your real estate investments, these 5 deductions are worth knowing.
There are plenty of benefits of being a real estate investor, but when it comes to tax season, here are five tax breaks you can take advantage of. Of course, you should always have a detailed conversation with your Certified Public Accountant (CPA) about your tax situation and which deductions are right for you as a real estate investor. Tax strategies and the types of expenses you incur may look a little different if you’re a property flipper or a landlord, for example. This list can get you started in the right direction.
1. Expenses directly related to the property
Your real estate investment business is a business . That means you can deduct some of the expenses that you encounter when operating your portfolio. Some of these expenses are directly tied to owning property and they include things such as:
- Mortgage interest
- Property tax
- Operating expenses
- Supplies, repairs, maintenance to keep the property in operating condition. Please note that this does not include the cost of improvements, which is recovered through depreciation.
The IRS breaks down the types of expenses you can take into two general categories:
- Ordinary expenses related to managing, conserving, and maintaining the property. These are common and accepted in the business such as property management fees.
- Necessary expenses such as interest, taxes, advertising, maintenance, utilities, and insurance.
How you write off these deductions might depend on what kind of real estate investing you’re doing. If you’re flipping the property, for instance, you won’t be able to claim things like the cost of materials for a renovation until after the property is sold.
Other situations to ask your tax preparer about
As an expense, you can capture the mundane, like the pens you buy to take notes with or the phone or computer you use to conduct business. This category also includes your office space. In some situations, you may be able to claim a portion of your own rent or mortgage and a percentage of your utilities if you have a home office.
Are you driving to and from rentals or taking trips to visit potential flips? Those who drive for their business can track it to claim the IRS standard mileage deduction. There are mileage tracker apps that can help you with this.
Meals out with business contacts can also be an expense at 50 percent, but like anything you claim, you’ll want to keep receipts and keep a log to record what the meeting was about and who it was with. Travel expenses are also eligible, this could be train tickets to see a new property, or plane tickets and hotel for a real estate investment conference. Ask your tax preparer for a list of business expenses that you should be tracking. And do a deep dive into the IRS’s own explainers.
Even if you’re new to real estate investing, depreciation may be a tax strategy you’re familiar with. The idea behind depreciation is that instead of taking the cost of an item as an expense all at once, you take it over time. In the case of an expensive computer, for instance, you could choose to depreciate the cost of it over time (five years).
You can also depreciate building structures ranging from single-family homes you rent out and apartment buildings to any structures on the property such as parking lots and more. Although this depreciation is taken over 27.5 years for residential real estate and 39 years for commercial real estate, both offer advantages to investors.
Note that land isn’t eligible and you’ll have to account for that. To make sure you’re handling the depreciation of buildings on your investment property correctly, it’s advised that you work with a tax professional with experience in real estate investment. The IRS has in-depth information to help explain the right way to depreciate an investment property.
3. Capital Gains
Short-term capital gains
A real estate investor pays capital gains taxes in one of two ways. If you’re selling and making a profit from a property having bought and sold it in under a year (such as with a fix and flip), you’ll pay short-term capital gains. This means the money you make on the sale of the property is counted as regular income and you’re taxed accordingly.
Long-term capital gains
If you own a property for more than a year and then sell it, you’ll be paying long-term capital gains — a rate that’s lower than that of short-term capital gains. If your income is low enough, this may not apply. You can also take advantage of certain incentives (see below) to mitigate some of the effects of long-term capital gains.
4. Incentives: 1031 Exchange and Opportunity Zones
The 1031 Exchange is a 100-year-old tax provision that’s still favored by investors and here’s why. The tax provision, so named for Section 1031 of the IRS tax code, allows an investor to sell one investment property and buy another — and defer the usual capital gains tax. You’re essentially trading one property for another and postponing having to pay capital gains when you do so. In theory, you can do this until you die or until you’re ready to cash out. See what the IRS has to say about these “like-kind” exchanges.
Opportunity Zones are a special incentive that lets you defer and/or reduce your capital gains tax liability. You get to invest your money in underserved communities and be part of bringing an economic boost to an area that needs it. You can’t just go out and buy a building in a designated opportunity zone with proceeds from a property sale (or sale or other assets), though to qualify for this special incentive. Instead, you’ll take the money you made and invest it in a Qualified Opportunity Fund. It is possible to create your own fund, but you’ll want to make sure you follow the rules on doing so. The IRS covers the ins and outs of investing in an Opportunity Zone on its website.
5. Navigating the self-employment tax
Being self-employed as a real estate investor is great on a number of levels. You make your own schedule and are the master of your destiny — and make money while doing it. However, you are often on the hook for more taxes than a regular W-2 employee since you’re both employer and employee. If you’re a landlord with rental income, however, the money you collect in rent isn’t classified as earned income. As such you may get to skip out certain self-employment taxes, such as FICA or payroll tax. You do still need to report it properly to the IRS and pay other taxes on it, though.
Do your homework
Don’t assume that because you’ve done your taxes on standard W-2 or 1099 income that you can also do your taxes as a real estate investor, especially if you’re new to real estate investing.
It’s always wise to consult a tax professional. You could save yourself a lot of time, hassle, aggravation, and money by talking to someone who knows the complex and ever-changing U.S. tax codes. Ideally, you’ll want to choose a tax professional who has experience with property investors.