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Today we are talking about
The 9 Tax Benefits of Real Estate
Alright so I’ve pulled this information off of multiple sites online. If you want to check out the full blog the link is in the description. But these are some great tax benefits when it comes to Real Estate. I’m actually going to school to get my Real Estate license and I will be posting much more Real Estate content and property walk-throughs.
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Anyway let’s get into the topic on hand: The 9 tax benefits of real estate.
- Depreciation
When it comes to Real Estate this is a deduction of the value over time. The IRS actually gives you 27.5 years to claim the depreciation on an investment property.
2. Rental Income
THis is considered passive income by most but not by the IRS. Its actually considered passive activity income. Before 2018, the only way to offset passive income was with passive losses. But when the Tax Cuts and Jobs Act was passed, it allowed businesses who earned qualified business income (QBI) which includes rental income, to pass up to 20% of taxable income using a pass-through deduction. It’s important to note that you can only take advantage of the pass-through deduction if your business is profitable and not all income types qualify for this deduction, which is currently available until 2025.
3. Appreciation
Over the long-run real estate has gone up in value about the same rate as inflation (3-4%). This passive style of inflation helps, but active appreciation is even more profitable. Active appreciation happens when you force the value higher over a shorter period of time, like with a house remodel.
4. Capital gains
As of 2018, long-term capital gains tax rates are between 0% to 20%, depending upon your tax bracket. Of course, the shifting political climate can always change these rates. But in general capital gains tax rates are lower than ordinary income tax rates.
Low capital gains rates are an advantage if you build your long-term investment strategy around strategically selling real estate for growth or living expenses.
5. Live in flips
What if you want to avoid capital gains tax altogether? Then just buy and immediately move into the house as your principle residence. As long as you live in the home 2 out of the next 5 years, in the U.S. you can make a tax-free profit of up to $250,000 as an individual or $500,000 as a couple. Canada and the U.K. have slightly different rules, but the principle is the same
6. Tax-free exchange
Another way to avoid capital gains tax (and also depreciation recapture tax) is a section 1031 tax-free exchange. This technique is named after section 1031 of the U.S. tax code.
A 1031 exchange allows you to trade one property for another without paying taxes. You must follow specific rules, and you must be classified as an investor (i.e. not a dealer who flips houses).
Why is this helpful? Because you get to use 100% of the profits from the sale to reinvest in the next property. This maximizes the growth and compounding of your investments.
For example, let’s say you sell a property for $300,000 without a 1031 exchange and pay $35,000 in capital gain and depreciation recapture taxes. By avoiding these taxes using a 1031 exchange, you would keep that $35,000 invested. At 10% for the next 20 years, that $35,000 would grow to over $235,000!
7. Tax-free borrowing
You can simply pull capital out of an investment tax-free by refinancing. This is a great way to build out your real estate investment without having to set up a new mortgage
8. Installment sales
Like 1031 exchanges, installment sales are only available to property investors and not to dealers (house flippers). Also like 1031 exchanges, installment sales allow an investor to defer capital gains tax, but unfortunately the entire amount of accumulated depreciation must be recaptured at the initial time of sale.
9. Self-directed IRAs
IRAs and 401k style retirement plans are incredible tools to build wealth while minimizing taxes. But most people think of them only as tools to invest in traditional investments like stocks, bonds, mutual funds, and REITs. While this is the norm, it’s not the rule.
The IRS does not describe what your IRA account can invest in. It only describes what you can NOT invest in. The “do not invest list” includes life insurance and collectibles like artwork, rugs, and antiques. Non-traditional investments like real estate, private mortgages, limited partnerships, and tax liens are therefore allowed. But most larger retirement account custodians (i.e. Vanguard, Schwab, etc) do not choose to offer them as a possibility.
So there you have it: the 9 tax benefits of real estate. Of course there are more but i figured I’d give you a few I liked. If you want to check it out in writing then go to the description below and check out the blog.
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