Many people these days are looking for opportunities to generate passive income. If you’re one such person, then you should know that one of the best ways to do that is to invest in real estate, which is one of the most popular side jobs for people looking to improve their financial health, and for a good reason. Investing in real estate is an extremely worthwhile venture that provides one of the highest returns on investment, more so than investing in stocks and bonds. Not only is it a source of appreciating cash flow, but it’s also an effective way to build equity and wealth and diversify a portfolio.
Perhaps one of the most significant benefits of expending money into real estate properties is the numerous valuable tax breaks available to investors — on everything from commercial buildings, apartments, raw land, and rental properties. It pays to know what tax breaks are out there so that you can take full advantage of these benefits. Below are some of the best tax benefits you can expect when real estate investing and how you can make the most out of them.
Multi-Family Property. If you’ve filed for a loan with a multi-family lender, then you may be eligible to deduct the interest from your monthly payments granted that the loan is worth anywhere from $750,000 or up to $375,000 if you’re a married couple who is filing for the loan separately. In certain states, you may also be eligible to deduct up to $10,000 of property taxes or up to $5,000 if you’re a married couple who is filing separately, depending on where you live and what laws apply.
Passive Income. Passive income refers to money obtained through any type of business operations that investors aren’t involved in. In this case, it’s income from rental fees. According to the Tax Cuts and Job Act of 2018, businesses that earn a qualified business income (QBI) are entitled to take advantage of a pass-through deduction. This allows you to simultaneously deduct your net income and reduce your income rate by almost 20%.
Other basic expenses associated with real estate investment property that can be written off as a tax deduction include mortgage interest, property tax, property management fees, and property insurance, among many other things.
If you purchase the property through a limited partnership (LP) or a limited liability company (LLC), then various other tax deductions are also available to you besides those already mentioned, including but not limited to:
- Office equipment
- Advertising expenses
- Travel expenses
- Professional fees
Depreciation is a type of tax deduction that takes into account the cost of purchasing and developing a real estate property, as well as deducting its subsequent loss in value over the course of its life. This is a tax benefit that only applies to properties used for investment purposes. These deductions happen every year and are determined by three main factors: how much the property is worth, the depreciation method used, and the cost recovery period of the property.
Capital gains refer to an increase in the property’s value that’s only realized when you sell it. They’re taxed using two methods: long-term and short-term capital gains. Long-term capital gains are applied to any properties that have been in your possession for over a year, whereas you can get short-term capital gains from capital assets that you’ve owned for only one year or less.
Like pass-through deductions, opportunity zone funds were established in 2018 when they were included in the Tax Cuts and Job Act. There are over 8700 opportunity zones across the country, mostly in rural areas. You’ll need to take advantage of this benefit to allocate your capital gains into an opportunity zone fund, which exempts you from paying capital gains tax, depending on how long you keep your investment stored in the fund.
A 1031 Exchange is the exchange of one real estate property investment for another one, which results in the deferment of capital gains tax. The term is derived from Section 1031 of the Internal Revenue Code. You can shift your capital gains from one property investment to another, free of taxes, until you decide to sell it after one year. You can only avail of this benefit if your replacement property’s value is equal or greater than the previous property, if you’re exchanging one’s properties for another asset, and if the property is only used for investment purposes.
Familiarizing yourself with all the tax breaks available to you when purchasing an investment property allows you to take full advantage of them. Keep these benefits in mind and make good use of them with your own investment.