Tax Advantages of Owning Investment Real Estate
Tax Advantages of Owning Investment Real Estate
One of the best ways to find tax benefits is through real estate investing. Just like owning your own home has tax advantages, ownership of investment property provides many tax deductions that offset income received. This is opposed to traditional assets such as stock, mutual funds and CDs.
Income property can range from commercial to residential, and is bought for earning profit through renting, leasing, or price appreciation. I will list and describe ten of the many deductions that are allowed.
Interest is often the largest deductible expense. Mortgage interest on loans used to acquire or improve rental property and interest charged on credit cards for goods and services used in rental activity are deductible.
This is my favorite deduction. The cost of the building whether residential or commercial is fully depreciable. Residential is depreciated over 27.5 years and commercial over 39 years. What I like so much about depreciation is that it is possible to have a positive cash flow on the property while showing a net loss on your tax return because of the depreciation taken. The cost of improvements that increase the property’s value can also be depreciated. I’m sure that there are not many other investments that allow this.
- Repairs & Maintenance.
The costs of repairing and maintaining rental property (if they are ordinary, necessary, and reasonable in amount) are fully deductible in the year in which they occurred. Examples are painting, fixing leaks, repairing HVAC systems, and yard care.
In some situations, landlords may be responsible for the utility payments on the leased property. Normally this occurs when there are more than one living quarters or offices that share the same meter of the service. Also, this can happen when there are common areas that are shared by more than one tenant, such as associations that have dues that benefit all the tenants in the occupied property. These expenses are fully deductible.
Premiums paid for almost any insurance including fire, theft, flood, and liability are deductible. If the landlord has employees, the cost of health and worker’s compensation insurance can also be claimed.
- Legal & Professional Services.
Fees paid to attorneys, accountants, property management companies, real estate investment advisors, and other professionals are deductible if the fees are paid for work related to the rental property.
- Vehicle & Travel.
When a vehicle is driven to the rental or to a store to get supplies, the expense is deductible for that property. Either the actual costs of gas and repairs and maintenance can be used, or the standard mileage rate, which is set annually by the IRS. In most cases, the standard mileage rate is the most beneficial of the two methods. Long distance travel, such as airfare, hotels, meals, etc., is also allowed. It is even possible to mix pleasure with the travel if the business portion is properly documented.
- Home Office.
While meeting certain requirements, landlords may deduct home office expenses. This deduction takes the annual cost of maintaining the home and pro rates these expenses (including depreciation) by the portion (square footage) devoted to the office and workshop area, for rental activity.
- Deferral of Taxes Upon Sale of Property.
The gain on the sale of investment property, if held more than one year is subject to favorable long term capital gain taxation. This can be deferred, however, by at least two methods. One is via a Section 1031 exchange (I have done many of these) where the decision has been made to sell the property and use the funds from the sale to purchase a like kind property within a specified amount of time. Thus, the taxable gain is deferred until at some point the investment is sold and the funds are not exchanged for another property. There is caution needed when this happens because the previous depreciation taken may be subject to the recapture taxation. The second method of deferral is selling the investment asset on an installment basis through seller financing. This way, the seller recognizes the gain on a longer-term, when payments are made, and receives interest income over the life of the loan. If the investment property is never sold by the investor, heirs may inherit the property on a “stepped up basis”, meaning that they acquire it at the market value at the time of the original investor’s death.
- Passive Taxable Income.
The positive income generated through an investment rental property is considered “passive” income. This means that it is not subject to self-employment taxes. This is favorable to the investor as this tax can be as much as 15.3%.
Have other questions about real estate taxes on your investment property? Please contact me and let me know how I can help you.