UPDATED: February 14, 2023

It's no secret that real estate taxes may be difficult to understand. The Internal Revenue Service (IRS) has a seemingly limitless number of restrictions governing what you can and cannot do as a real estate investor in terms of taxation.

The long and short of it is that taxes are complicated, publications on the web are full of convoluted verbiage, and individuals like you are missing out on opportunities to put more money back in your pockets.

Therefore, we wanted to provide some crucial tax suggestions for real estate investors to help them deal with real estate investor taxes better in a straightforward guide that is easy to read and understand.

1) Maximize Your Business Deductions

Deductions from income are one of the most significant tax benefits offered to investors in the form of investment property. These tax write-offs, which are often reserved for landlords and property managers who oversee rental properties, will cover expenses such as mortgage interest, property tax, operating expenses, depreciation, and maintenance. 

As a property manager, you are entitled to deduct the regular and necessary expenses incurred in the course of managing, conserving, and sustaining the property from your income.

Mortgage interest, property taxes, advertising, upkeep, utilities, and insurance are just a few of the expenses associated with running a business. Investors can deduct the cost of repairs because they keep a property in excellent shape and do not increase the value of the property in any way. Repairing leaks, painting, and replacing broken sections of the rental property are examples of what you might be expected to do.

Investors can also deduct the interest they pay on their primary — and sometimes secondary — residences from their taxable income. This deduction is available for home purchases or freshly refinanced mortgages, as well as home equity lines of credit and home equity loans, among other things. 

2) Hold on to Properties for Over a Year

Although fix-and-flips can be extremely profitable, they are also subject to a high rate of taxation. Short-term capital gains tax is levied on properties that are purchased and sold within 365 days of each other. This implies that the money you earn will be added to your income, and you will be taxed at the rate that corresponds to your tax bracket.

Long-term capital gains, which include gains from properties held for more than a year, are taxed at a rate of 0 percent, 15 percent, or 20 percent, depending on your tax bracket. This is critical since delaying the sale of your property even for a short period of time could have a major influence on the amount of income tax you would owe.

3) Harness Power of 1031 exchanges

A 1031 exchange, often known as a “like-kind” exchange, is a fantastic instrument for you as an investor to utilize. In this case, you can postpone (pay at a later date) taxes on the income from the sale of your home if you use the money you get to put toward the purchase of a new home.

As a real estate investor who primarily invests in single-family rental properties, the 1031 exchange gives you a greater degree of flexibility in terms of buying and selling assets without constantly worrying about being taxed on each transaction. This allows you to build a larger portfolio while also deferring taxes.

4) Conduct an Installment Sale

Consider the following scenario: you sell a house for a $50,000 profit. You don't want to conduct a 1031 exchange to purchase a new property right away, for whatever reason you have. If you submit your tax return with an additional $50,000 in taxable income in a single year, you can expect to pay a significant amount in taxes on that income, which may push you into a higher tax bracket than you would otherwise be in.

Offering seller finance as an alternative could allow you to spread the earnings over a longer period of time. During the year that you sell the property, you will only be responsible for paying income taxes on the down payment and principal that the buyer gives you. They progressively pay down the debt they owe you, month by month and year by year, over the course of time. Even better, you will be able to charge the buyer interest on their purchase.

5) Depreciate Your Properties

Depreciation is another type of paper expense that real estate investors can take advantage of. The IRS has determined that a residential building has a life expectancy of 27.5 years, which means that property owners can deduct 1/27.5 (or 3.636 percent) of the building value of their property each year for the first 27.5 years that they possess the property.

To illustrate, consider the following scenario: you acquire a property for $150,000, with the land worth $50,000 and the building for $100,000. You can deduct $3,636 for depreciation each year for the next 27.5 years: $100,000 divided by 27.5 is $3,636 every year.

You can also deduct the cost of any major upgrades made to the building. For example, if you spend $8,000 to install a new roof, you can depreciate that $8,000 over a period of 27.5 years, saving you money. The good news is that this is the case. The bad news is that when you sell the property, you'll be required to pay taxes on “depreciation recapture,” which is a tax on all earnings that you had previously avoided paying taxes on by depreciating the property's value.

Of course, if you never sell your property, you will never have to pay those taxes. While tax laws are complicated, the tips we’ve highlighted should help you avoid some of the most common pitfalls for real estate investors.

If you have any questions about how these principles might apply to your specific situation or want more information on taxes in general, please contact Taxes for Landlords today. We are here to answer all of your questions about real estate taxes, including rental income.