Let’s be honest, taxes can be quite the headache. There are a seemingly endless series of guidelines and rules from the IRS saying what you can and cannot do as a real estate investors when it comes to fulfilling your tax obligations.
Put simply, taxes are highly nuanced, articles online are jam-packed with barely comprehensible financial jargon, and readers like you are on the losing in as far as keeping more of your hard-earned money where it belongs: in your pocket. That’s why we wrote this article—to unpack some of the more significant bits of tax advice for real estate investors looking to finish the year on a high note in a straightforward, plain-English format.
- Get Down to Business
Technically, real estate investors are their own business entity—meaning you are privy to business deductions. Have you ever seen a guy in a suit and tie cramming a receipt in their pocket after finishing a meal at a restaurant? There’s a good chance they were holding onto that receipt to write off the expense. The same concept applies to real estate investors: if you’re spending money for the furtherance of your business, there’s a chance you may have the opportunity to recoup the tax you shelled out. For instance, if you purchased $1,000 worth of lumber for a property and you were hit with a 6% sales tax, you would be allowed to subtract that from the taxes you will owe at the close of the year. But tax deductions are not limited to the construction site—nearly any type of business-related expense can be written off, to include:
- Mileage: Travelling to and from your investment properties? The IRS allows investors to write off 57.5 cents per mile you travel as long as it is for business
- Interest: When you are involved in a property transaction you will have to take out hard money loans and these balances will have some type of interest factored into them. The upside is that all of the home mortgage interest, points, and mortgage insurance premiums can typically be written off as tax deductions. Keep in mind, however, that recent legislation has capped the amount of deductions at $750k in mortgage debt.
- Professional Services: If you have a property manager, attorney, CPA or any other kind of professional service provider on your bank roll, you will more than likely be able to write them off as long as the service was directly associated with your investment portfolio properties.
- Depreciation: Inevitably, your investment properties will incur some form of wear and tear over time. The IRS allows investors to claim that a given property will depreciate over the course of 27.5 years—meaning that with every passing year, the amount of the value of your improvements to the property (i.e. capital expenditures) are allowed to be deducted from ordinary taxable income for 27.5 years.
Derrick Foote, Owner of Duner and Foote, a California based CPA firm stated the following: “For business owners, year-end purchases can help reduce income under the expanded Code Section 179 and bonus depreciation provisions. Purchasing qualifying fixed assets that are eligible for the Code Section 179 and bonus depreciation provisions will allow you to reduce your income by the entire purchase price of the asset for federal tax purposes. Not all states conform to these accelerated provisions so you will want to confirm if the state you or your business resides in conforms to these rules.
Also, for business owners there is an opportunity to maximize your Qualified Business income (“QBI”) deduction. This QBI deduction is available for pass through entities (partnerships, S Corporations, Limited Liability Companies, and sole proprietorships). The QBI deduction could be up to 20% of the QBI generated by the qualifying trade or business. The taxpayer may want to due a preliminary calculation to determine their net benefit from this incentive. There are certain provisions that could limit this benefit which include the (W-2) wages your company has paid in conjunction with the unadjusted basis of qualified property held by a business. An additional bonus to the owner at year end could help increase the wage expense to maximize a business’s QBI deduction.”
- Take Advantage of 1031 Exchanges
Also referred to as a ‘like-kind’ exchange, a 1031 exchange is a valuable tool for all real estate investors. This enables you to defer taxes on the income garnered from a given property that you sold if you immediately use that money towards funding the purchase of a different property. This is particularly useful for investors focusing mainly on single-family rental properties, as the like-kind exchange model provides them with a certain degree of financial flexibility to transact assets without having to be concerned about the inherent tax associated with every single sale—helping them compile a more extensive portfolio while deferring taxes in the process of doing so.
- Refinancing Tax-Free
If you are contemplating the decision to refinance, be sure not to make taxes associated with the transaction a determinative factor—you can essentially extract equity out of a property currently in your portfolio with a cash-out refinance and dodge any major negative tax implications. This is because no actual sale is taking place and you are not making a profit necessarily, meaning the IRS does not label this asset as taxable income. Refinancing is a favored move for real estate investors who want to reallocate some cash from one property to another.
At Express Capital Financing, we believe in putting our real estate investors first. We want to help you be successful through all avenues and look forward to partnering with you in 2021.
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