Real estate investing provides consistent and recurring rental income every month, long-term appreciation with properties that grow in value, and a financial foundation that can set you up nicely for retirement or other current and future goals.
Investing in property also comes with tax benefits.
If you’re not already working with a CPA or a financial planner, you should think about exploring those services. Talk to a San Diego property manager, too. We can make sure you’re taking all of the tax advantages that are available to you. Some of the available deductions may be obvious to you, but there are likely others that you have not considered. Surrounding yourself with professionals can ensure you’re taking every possible tax benefit and saving yourself money with your rental investment.
Whether you’re preparing to do your taxes for the next year or you’re wondering whether it’s worth your resources to invest in rental property and real estate, we want to go over some of the key tax benefits that are available to you as an investor.
Always seek specific help that pertains to your unique financial situation. Every investment portfolio is different, and your tax advantages may be different from year to year.
Here’s what we can tell you.
Common Deductions for Rental Property Investments
The income you earn in rent must be declared on your taxes. However, that tax liability can be reduced when you consider the deductions you’re permitted to take on the losses you suffer as an investor. Here are the most common deductions and write-offs you should be taking:
Deducting Mortgage Interest
Unless you’ve paid cash for your investment property, you likely have a mortgage on it. When you’re renting out that property, you can deduct the amount you pay in interest on your loan. The interest deduction does not stop there. If you have a credit card, for example, that’s only used to support your real estate business, you can deduct any interest that you pay on that card.
Deducting Property Expenses
Think about the money you spend in order to keep your investment property operating. You’ll have insurance premiums to pay, property management fees, and even bills from accountants, lawyers, and real estate brokers. Those fees are all tax deductible.
Perhaps you live out of state and you travel to your rental property from time to time to rent it out, oversee turnover renovations, or evict a tenant. Those travel costs can be used as deductions when you file your taxes.
You can also deduct the amount of money that’s required to keep your property safe and habitable. When there are repairs that come with a hefty price tag, you can deduct what you spend at tax time. This makes the shock of that repair bill a bit more manageable.
Keep in mind that while maintenance costs are deductible at tax time, you cannot deduct any renovations or improvements that you make to the property. Only those repairs that address habitability can be written off.
Depreciation as a Tax Benefit
The IRS allows property owners to depreciate their rental homes if they meet a number of important criteria. First, you have to be the property owner. Second, you need to generate income of some sort from the property. Your rental income will qualify. Finally, you have to have used the property as an income-producing investment for at least one year. Flipping a property that you bought and sold in the same year would make you ineligible for the depreciation deduction at tax time.
For purposes of your tax deduction, the IRS sets 27.5 years as the amount of time that your rental property is useful. You won’t use your purchase price to determine how much of a deduction you get for depreciation every year. Instead, you need to use the cost basis as the calculated value of your asset. The cost basis will include increased value due to renovations, any debt that the owner takes on from the seller, and other variables.
There’s also an adjustment to be made for the land your property sits on. While you’re allowed to depreciate the building or the home itself, the land is not included in your depreciation write-off.
Tax Benefits to a 1031 Exchange
One of the most important tax benefits for real estate investors is the 1031 exchange. This program allows you to defer the capital gains taxes you’d pay on the sale of an asset, as long as you reinvest the proceeds into another income-producing investment property.
With property values growing over the last couple of years, any rental home you sell right now is likely to deliver some impressive profits. What will you do with that money? If you walk away from the sale with your money, you have to pay taxes. If you put that money into escrow with a qualified intermediary, you can use it to but another property or even more than one property, depending on how much you earn when you sell.
There are some caveats.
You need to exchange like properties. So, you can sell a single family home and buy a duplex or you can sell a small apartment building and buy a couple of condos. You have to sell an income property and buy another income property. You cannot invest your proceeds into a vacation home for yourself.
There are strict timelines. You’ll need to identify a new property to exchange within 45 days of selling the existing one. Then, you’ll need to close the deal within 180 days.
You cannot touch the funds from the sale. Your qualified intermediary will be responsible for transferring the money from sale to purchase.
A 1031 exchange is an excellent way not only to defer taxes, but to strengthen the size and scope of your investment portfolio.
We always encourage investors to talk with their CPA or their tax attorney before they invest in real estate. You want to know where you stand and what kinds of benefits and costs you can expect when it comes to taxes.
If you’d like some help understanding how you can save on taxes by investing in rental property, we’d love to tell you more. Please contact us at North County Property Group.