4 Tax Tips for Real Estate Investors

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In this period of growing uncertainty, real estate remains to be one of the best ways to grow and safeguard wealth. 

Property values are soaring at the fastest rate in nearly 50 years, and will only increase as cities become bigger and more affluent. And as more people move to urban areas, the demand for residential, retail, and office space will continue to rise.

It also helps that the U.S. tax code is favorable to real estate investors. Owners of real properties such as apartments, commercial buildings, and land can capitalize on federal, state, and local incentives to reduce their tax liability.

However, taxes can be confusing, and you may be missing out on these tax advantages if you're new to real estate. Here are a few tips to save money on real estate taxes.

 

Know your deductions to save on real estate taxes


You can shave thousands of dollars off your tax bill just by deducting your expenses. Maintaining residential or commercial real estate can pose a heavy financial burden on real estate investors

For a real estate expense to be deductible, it must be considered both "ordinary and necessary". According to the IRS, an ordinary expense is common and accepted within the industry. Meanwhile, a necessary expense is helpful and appropriate. Deductible expenses for real estate investors include the following:

 

Real estate and property taxes


For tax year 2022, real estate investors can deduct up to $10,000 for income, sales, and property taxes paid to a state or local government. 

However, there is a possibility that taxpayers may be able to deduct more if President Biden's Build Back Better Act is passed by Congress. One of the proposed provisions of the Build Back Better Act is to raise the state and local tax (SALT) deduction cap from $10,000 to $72,500. If passed, the legislation would boost the SALT cap from 2021 through 2030.

 

Mortgage insurance premiums


The IRS considers mortgage insurance premiums as an "ordinary and necessary" expense, and are therefore deductible. The deduction must be claimed for the tax year the mortgage insurance premium was paid and accrued.

 

Property management fees


If you have outsourced property management to a third-party firm, any fees paid to them are considered as an "ordinary and necessary" business expense. You can deduct any property management fees from your tax liability.

 

Maintenance costs


One of the biggest costs of owning real estate is upkeep. Thankfully, you can claim a deduction for the cost of property repairs and maintenance. However, for an expense to be deductible, it must be considered as a repair and not an improvement.

Repairs consist of actions taken to restore the property to its original condition. This may include repainting the walls or replacing broken fixtures. Meanwhile, improvements such as installing a security system or adding a gazebo increase the value of the property, and are non-deductible.

 

Business expenses


If you run a real estate business, you can deduct costs such as support fees, legal fees, home office expenses, travel expenses, and advertising expenses from your tax return.

 

Avoid flipping real estate


Real estate flipping (i.e. buying a property and quickly selling it for profit) are subject to different rules than other real estate investors. 

For starters, profit from flipping is taxed at the standard income tax rate instead of the lower capital gains rate. And if you sell more than two properties in a year, the IRS may classify you as a dealer, which means your Social Security and Medicare (FICA) taxes are doubled.

To minimize your tax liability, consider holding your properties for at least 13 months before selling them. Waiting a year before selling means the profit from the transaction is now classified as a long-term capital gain: Your earnings are taxed at a lower rate and are exempt from FICA taxes.

If you're worried about your properties sitting empty for a year, you may rent them out for a short lease before flipping them. This way, your properties provide you with a revenue stream while you wait out the 13 months.

Another option would be to live in the property for at least 2 years. According to IRS rules, the first $250,000 of capital gain from the sale of a home is deductible from your income. That figure is doubled for married couples.

 

Use the 20% pass-through deduction


The Tax Cuts and Jobs Act of 2017 introduced a tax benefit that could save real estate investors thousands of dollars on taxes. 

If your real estate business is classified as a pass-through business (i.e. a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax), you can deduct up to 20% of your net business income, or qualified business income.

For tax year 2022, the qualified business income deduction threshold is $170,050 for single filers and $329,800 for married couples filing jointly. 

The rules can be complicated, which is why you will need to talk to a tax professional if you wish to take advantage of this tax perk.

 

How to file a real estate investor tax return


It's no secret that taxes can be a burden, especially if you're in real estate. The rules are always changing and you're not sure which deductions and benefits you qualify for. If you have questions such as which tax forms to use, your best option is to talk to a tax professional.

You can trust the experts TFX to give you the advice you need. Our experienced team can help you determine which tax benefits you qualify for and save you thousands of dollars.