Investing in real estate is not only a great way to build long-term wealth but it also provides a number of tax benefits and deductions that can help reduce your tax liability. In this article, we will explore some of the key tax benefits and deductions that come with investing in real estate.
One of the biggest tax benefits of owning real estate is the ability to claim depreciation on the property. Depreciation is a tax deduction that allows you to recover the cost of the property over time. The IRS allows you to depreciate the cost of a residential rental property over 27.5 years and commercial property over 39 years. This means that you can deduct a portion of the cost of the property each year for the next 27.5 or 39 years, depending on the type of property.
Another major tax benefit of owning real estate is the ability to deduct mortgage interest on your tax return. If you have a mortgage on a rental property, you can deduct the interest you pay on the mortgage each year. This can be a significant deduction, especially in the early years of a mortgage when most of your payment is going towards interest.
Real estate investors can also deduct property taxes on their tax returns. This includes both state and local property taxes. Property taxes can be a significant expense for real estate investors, so being able to deduct them can help reduce your overall tax liability.
Repairs and Maintenance
Another deduction that real estate investors can claim is for repairs and maintenance on their rental properties. This includes things like fixing a leaky roof, repairing a broken window, or repainting the walls. These types of expenses can be deducted in the year they occur and can be a significant deduction for real estate investors.
Real estate investors can also deduct travel expenses related to their rental properties. This includes things like driving to the property to check on it, meeting with tenants, or traveling to attend a real estate conference. These expenses can add up quickly, so being able to deduct them can be a significant tax benefit.
Home Office Deduction
If you have a home office that you use for your real estate investing business, you may be able to deduct a portion of your home expenses, including mortgage interest, property taxes, utilities, and repairs and maintenance. To qualify for this deduction, you must use the space regularly and exclusively for your real estate business.
Real estate investors can also claim passive losses on their tax returns. A passive loss is a loss that occurs when your rental property expenses exceed your rental property income. This loss can be deducted from your other passive income, such as income from stocks or bonds. If your passive losses exceed your passive income, you can carry the losses forward to future tax years.
Real estate investors can also take advantage of a 1031 exchange to defer capital gains taxes when they sell a rental property. A 1031 exchange allows you to sell a rental property and reinvest the proceeds into another rental property without paying capital gains taxes. This can be a great way to build your real estate portfolio without having to pay a significant amount of taxes on the sale of your rental property.
Opportunity Zones are a new tax incentive program that was created as part of the Tax Cuts and Jobs Act of 2017. These zones are designated areas in low-income communities where real estate investors can invest in new projects and receive significant tax benefits. If you invest in an Opportunity Zone project, you can defer taxes on capital gains until 2026 and receive a 15% reduction in taxes on the capital gains if you hold the investment for at least 7 years.
Real Estate Professional Status
Real estate investors who are considered “real estate professionals” by the IRS can take advantage of even more tax benefits. To qualify as a real estate professional, you must spend more than 50% of your working hours and at least 750 hours per year in real estate activities, and you must also materially participate in those activities. If you meet these qualifications, you can deduct all of your rental losses against your other income, not just your passive income.