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Tax Tips for Real Estate Investors - In Plain English

It’s no secret, taxes can get confusing. There are seemingly endless regulations from the IRS on what you can and can’t do as a real estate investor as it relates to your taxes.

The long and short: taxes are complex, articles online are full of convoluted language, and people like you are missing out on putting more dollars back into your pockets.

That’s why we wanted to go over some important tax information in an easy-to-read, jargon-free article. We’re not CPAs, however, and we do recommend consulting with one before filing your taxes.

Let’s get to it.

You’re a business. That means you get business deductions.

Have you ever seen someone folding up a receipt and shoving it in their wallet after eating a meal at a restaurant? Chances are they were saving that receipt to “write off” the meal. If you’re doing anything for the benefit of your business, there’s a chance you may be able to recover the tax you pay.

For example, if you bought $1,000 worth of drywall for a place you own, and you were charged a 6% sales tax ($60), you would be able to deduct that from the taxes you will owe at the end of the year.

Tax deductions like this aren’t only reserved for construction projects—almost anything business related can be written off.

Below are the most commonly overlooked expenses you can write off as a business owner:

  • Mileage - Driving to and from properties? The IRS lets you write off 57.5 cents for every mile you put on your car if it’s business-related. Be sure to track your miles! Same goes for any other travel expenses you have as a result of managing your real estate business (airfare, accommodations, meals, etc). 
  • Part of your home - No ‘office,’ no problem. The IRS lets you write off part of your home as an office. As an investor, you’ll definitely be doing some of your business from home. This is a no-brainer deduction. Of course, there are two basic requirements for your home to qualify:
    • Regular and exclusive use - “You must regularly use part of your home exclusively for conducting business. For example, if you use an extra room to run your business, you can take a home office deduction for that extra room,” the IRS states. The space cannot be used for personal purposes.
    • Principal place of your business - According to the IRS, “you must show that you use your home as your principal place of business. If you conduct business at a location outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for a home office deduction.” Be sure to consult with your CPA for further interpretation of the term “principal.”
  • Interest - As you buy and sell properties you’re going to take out loans, and those loans will have some level of interest attached to them. The good part is that all of the home mortgage interest, points, and mortgage insurance premiums can actually be written off as tax deductions. It’s important to note, recent laws have set the limit of deductions of up to $750K in mortgage debt.
  • Professional Services - If you paid a property manager, lawyer, accountant or any other professional service provider this year, chances are you can write it off so long as the service was directly related to your rental investment property.
  • Depreciation - As your property experiences wear and tear, the IRS allows you to claim that your property will depreciate over 27.5 years. This means that every year, the amount of the value of your “improvements” (capital expenditures such as major property improvements/renovations like replacing a roof or finishing your basement) divided by 27.5 can be deducted from ordinary taxable income for 27.5 years. Translation: You have the potential to reduce the amount of income taxes you pay because of depreciation.

Let’s look at a simple example of this. If you own an investment property that is worth $100,000, you would divide $100,000 by 27.5. (Tip: The depreciable basis is what you paid for the property only and not the land. Your CPA can explain this further).

$100,000 / 27.5 = $3,636

Then let’s say this property creates $10,000 a year in rental income for you. Instead of paying taxes on the full $10,000, you would subtract the depreciation to give you the taxable number.

Taxable amount: $10,000 - $3,636 = $6,364 

Hold properties for more than a year.

Though fix-and-flips can be lucrative, they are also subject to a hefty tax rate. Properties bought and sold in under 365 days are subject to a short-term capital gains tax. This means the money you make will be added to your income, and you will be taxed in whatever bracket you fit into.

On the other hand, long-term capital gains, including properties owned for longer than a year, are taxed at 0%, 15% or 20% depending on your tax bracket.

Single Taxable Income Brackets

Ordinary Income

Long-Term Capital Gains & Qualified Dividends

Taxable Income Between

  10%

  0%

  $0 to $9,325

  15%

  0%

  $9,325 to $37,950

  25%

  15%

  $37,950 to $91,900

  28%

  15%

  $91,900 to $191,650

  33%

  15%

  $191,650 to $416,700

  35%

15%

  $416,700 to $418,400

  39.6%

  20%

  $418,400

Via irs.gov

This is important because waiting a little longer to sell your property could significantly impact how much you’ll be taxed on your income.

Let’s imagine two scenarios. In the first, you make $80,000 in a year, with $30,000 of that income coming from short-term investments. In the second, you make $80,000, with $30,000 coming from long-term investments.

Scenario 1 with short-term investments: $80,000 x .25 = $20,000 due in federal tax

Scenario 2 with long-term investments: $50,000 x .25 + 30,000 x .0 = $12,500 due in federal tax

By waiting at least a year, you’d take home an additional $7,500. Not too shabby if you ask us.

>>Related: Selling a rental property with tenants on a lease

Tap into the power of 1031 exchanges

Also known as a “like-kind” exchange, a 1031 exchange is a great tool for you as an investor. This allows you to defer (pay at a later date) taxes on the income from a property you sell if you take that money and put it towards purchasing another property.

If you’re primarily investing in single-family rental properties, the 1031 exchange gives you a lot of flexibility to buy/sell assets without having to worry about being taxed at every sale—helping you build a bigger portfolio while deferring taxes along the way.

There are some pros and cons of the 1031 exchange, so be sure to do your research and team up with the right partners who can set you up for success.

>>Related: Common misconceptions about IRC 1031 exchanges

Learn how Roofstock can help with 1031 exchanges

Tax-Free Refinances

If you’re thinking about refinancing, don’t worry about being taxed on the transaction. You can technically pull equity out of a home you currently own with a cash-out refinance and not get hit with a big tax bill. This is because no sale is taking place and you aren’t making money, so the IRS does not consider it taxable income.

Refinancing is a popular tip for real estate investors who want to take some cash and reinvest that equity into another property. And as stated above in the deductions section, the interest from this new loan will be a tax write-off.

Best Ways to Track Expenses

In 2018 it’s time to say goodbye to the shoebox full of receipts. There are many pieces of accounting software that will allow you to take photos and categorize receipts, meaning you don’t need the physical copy of your receipt.

It’s always best to record expenses as you pay for them—trying to do them in bulk at the end of the year is not only daunting, it increases the chances that you’ll miss a possible write-off.

Next up:

Pros & Cons of a 1031 Exchange

The above is for informational purposes only and is not intended to be investment or real estate advice. You should always consult with your professional financial advisor prior to filing your taxes.


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Written by the Roofstock marketing team.
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