Generating income and increasing owner appreciation aren’t the only ways investors hope to profit by owning a rental property. The tax code is full of tax benefits for real estate investors.
Here are my top 12 list of benefits for rental property owners:
- Deferral of taxes: When a rental property is sold, the depreciation expense is recaptured. In addition, the investor also pays capital gains tax on the profit from the sale. Investors can defer taxes by investing in a new property using a like-kind exchange. You can also do a 721 exchange to defer taxes. This will be discussed in a later blog article.
- Diversification: By investing in real estate, you’re diversifying your net worth from the traditional stocks, bonds, and mutual funds that most of your retirement money is invested in. If there is a market correction to the stock market, it might not affect your real estate portfolio.
- Free vacations: The IRS allows the owner to use each rental property for the greater of 14 days or 10% of the days the property is rented without affecting the tax status. So, if your rental property is rented for ten months of the year, you could use it personally for 30 days. This is a great motivator to own rental properties near where your family likes to vacation.
- Higher leverage: Some loans allow down payments as low as 3% for a single-family primary residence. The down payment requirement could be about 15% if you purchase a single-family investment property. A multifamily unit property could be as high as 25%. While some financial institutions will let buy stock on margin, none of them will have the leverage that real estate has.
- Interest deduction: When it comes to rental properties, there is no limit on the amount of debt you can have on a property. You can deduct the mortgage interest in full. However, you are limited to $750,000 of debt on your personal residence. You must also have itemized deductions high enough to surpass the standard deduction to deduct the personal mortgage interest.
- No FICA taxes: Generally, your profits from real estate are not subject to the FICA (payroll taxes) or self-employment taxes. This is a tax savings of 15.3%.
- Operating expenses: The everyday expenses of your primary home are not deductible. However, when it’s a rental property, expenses like insurance, HOA fees, utilities, and repairs are now deductible.
- Real estate taxes: You’re limited to deducting $10,000 in taxes on your return. Most taxpayers don’t get to deduct the entire amount of their real estate taxes. On a rental property, you get to deduct the whole amount of property taxes.
- Retirement funds: Did you know you can purchase real estate using your IRA account? By setting up a self-directed IRA, you can use your retirement funds to buy real estate. An IRA must have a custodian who manages the assets of the IRA. Since most custodians are financial investment firms, they invest in their products, typically stocks, bonds, and mutual funds. An IRA is allowed to invest in real estate, and companies will serve as custodians of your self-directed IRA. By working with one of these companies, you can use retirement assets to buy real estate. Warning: Self-directed IRAs come with many landmines. The IRS calls these landmines prohibited transactions. Understanding these rules fully is essential, or you could blow up your retirement account.
- QBI deduction: Rental properties may qualify for the Qualified Business Income (QBI) deduction. This allows owners to deduct 20% of the net profits from their income.
- Qualified Opportunity Zones (QOZ): By properly setting up a qualified opportunity fund (QOF) and investing in a QOZ, you can eliminate capital gains tax on the appreciation by holding the property for at least ten years.
- Tax-free cash flow: Rental property owners can depreciate the property’s value. Thus, it is not unusual for a rental property to generate positive cash flow and show a loss for tax purposes.
It’s important to talk to your attorney and tax advisor before buying a rental property to ensure you’re setting up the correct legal entity and choosing how that entity will be taxed. Fixing your mistakes later can cost you thousands and thousands of dollars.
If you would like to discuss your business or personal tax planning, tax preparation, and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton, PA office to discuss your situation. You can also schedule a consultation at Click Here.
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About Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS-licensed Enrolled Agent and a Certified Tax Resolution Specialist who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA. This includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, and West Chester. We also serve clients in Delaware, New Jersey, New York, and throughout the United States.
Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.
