Real estate investing can be highly lucrative, but it also presents unique challenges and opportunities when it comes to taxes.
Depreciation is a non-cash deduction that reflects the cost of wear and tear on your property. For residential real estate, the IRS allows depreciation over a 27.5-year period, while commercial property is depreciated over 39 years.
- Begin depreciating your property as soon as it's ready for rental.
- Use the Modified Accelerated Cost Recovery System (MACRS) for calculating depreciation.
- Consider a cost segregation study to accelerate depreciation.
- Ensure the property is used in a business or income-producing activity.
- The property must have a determinable useful life, exceeding one year.
Section 1031 of the Internal Revenue Code allows investors to defer capital gains taxes on real estate by reinvesting the proceeds from a sale into a new property.
- Use a Qualified Intermediary to hold the proceeds between sales.
- Identify the replacement property within 45 days and complete the exchange within 180 days.
Qualification Criteria
- Both the sold property and the new property must be used for business or investment purposes.
- Like-kind property can include any type of real estate held for productive use in a business or for investment.
Mortgage interest and property taxes are two of the most significant deductions available to real estate investors.
- Keep detailed records of all interest and tax payments.
- If you refinance, ensure you allocate any points over the life of the new mortgage.
- The mortgage must be secured against the property.
- Only deduct interest and taxes paid in the current tax year.
The Tax Cuts and Jobs Act introduced a 20% deduction on qualified business income for pass-through entities, which can include real estate investments held through LLCs, S corporations, and partnerships.
- Ensure your business qualifies under the IRS regulations.
- Consider restructuring properties into separate legal entities to maximize deductions.
- The investor's taxable income must be below a certain threshold to fully benefit.
- Specific service trades or businesses (SSTBs) may not qualify at higher income levels.
All ordinary and necessary expenses paid or incurred during the tax year in maintaining your rental property are deductible.
- Keep meticulous records of all expenses.
- Deduct property management fees, advertising costs, repair expenses, and utility costs.
- Expenses must be directly related to the rental activity.
- Capital improvements must be capitalized and depreciated, not expensed.
Employing these tax strategies effectively requires detailed knowledge of IRS rules and careful planning. Real estate investors should consider consulting with a tax professional to ensure compliance and to optimize their tax situation.
At RTW Advisors, we specialize in helping small business owners navigate complex tax regulations and optimize their tax strategies. If you have any questions or need assistance with your tax planning and preparation, please contact us.
Best regards,
Askia Roberts, CPA
RTW Advisors
