Real estate investment has always been considered a lucrative way to build wealth and for good reason. Providing a consistent flow of passive income from rental properties also presents the opportunity for significant financial returns upon the sale of the property. With great returns comes great responsibility, the responsibility of tax management. Depreciation is the most powerful tax deduction available to real estate investors. By deducting a portion of the investment cost over time, as the property depreciates, you can save on taxes. Suppose you acquired a rental property for $500,000.You depreciate the building (not including land) over 27.5 years at an annual rate of approximately $18,181 ($500,000 ÷ 27.5). It means that each year, you can deduct $18,181 from your taxable income without actually spending any money. Depreciation significantly reduces your taxable income and increases your cash flow by lowering your tax bill each year. When you sell the property for more than its depreciated value, there will be depreciation recapture taxes due on that portion.
Optimize your capital gains taxes
When selling an investment property for more than what it was originally purchased for, there are several options to consider when paying taxes on those gains.
- If possible and beneficial based on market conditions or personal circumstances such as relocation or liquidity needs, holding onto the property can be a way to defer capital gains taxes.
- A 1031 exchange allows you to sell one investment property and use the proceeds to purchase another investment property without paying any capital gains taxes. These conditions include finding a replacement property with equal or superior value within 45 days of selling the original property and closing on that replacement within 180 days.
- Opportunity Zone Funds allow investors to defer and potentially reduce capital gains taxes from not just real estate investments but other types of investments by investing in specific economically distressed areas designated by the government.
Deduct all allowable expenses
To ensure proper financial management, Brad Zackson investor should diligently track all expenses related to their real estate properties annually. By doing so, you’ll have more deductible expenses come tax season.
- Mortgage interest
- Property tax
- Insurance premiums
- Repairs and maintenance
- Utilities (if paid by the landlord)
- Property management fees and commissions
Managing taxes is complex, especially when dealing with multiple properties or unique tax situations. Hire an experienced accountant or tax professional who specializes in real estate investments. A professional helps you navigate the complex tax laws and ensure that you’re taking advantage of all available deductions, credits, and strategies. They also guide you in structuring investment deals to minimize taxes and maximize returns.