There are ten ways to pay less real estate taxes:
- Possess Real Estate Through a Self-Directed IR
- Maintaining Properties for an Extended period
- Avoid Paying FICA Taxes
- Tax Deferral Through a 1031 Exchange
- Take Advantage of Installment Sales
- Can deduct mortgage interest.
- Utilize the 20% Pass-Through Deduction
- Depreciation Deduction Claim
- Borrow Against the Value of Your Home
- Compile a List of All Expenses
- how to save money on taxes if you’re single
1. Possess Real Estate in a Self-Directed IRA
Almost certainly, you’ve heard of an IRA. An IRA is a popular type of retirement account in which you contribute money regularly to an investment that will eventually fund your retirement. When you open an IRA, you have the option of where your money will be invested. The best feature of an IRA is that you do not have to pay direct taxes on your contributions. Rather than that, you only pay taxes on withdrawals from your IRA after retirement (unless you opened a Roth IRA, which operates oppositely)
You can fund real estate investments like Kingdom Valley with an IRA account and avoid paying immediate capital gains taxes on the sale. It is referred to as a “self-directed individual retirement account.” This method of real estate investment is most effective when the property is purchased in cash.
Assume you wish to purchase a property. To begin, you’ll need to establish a legal entity for purchasing, owning, and selling rental properties. Numerous real estate investors opt for an LLC.
Then, you’ll pay a custodian or trust to open an IRA account on your behalf, with your LLC serving as the investment fund.
When the time comes to purchase a property, you’ll deposit the funds into your IRA. The funds can then be used to complete the transaction by your LLC. Because you are technically contributing to a retirement fund, you are not required to pay taxes on the purchase—at least not until you retire.
It is a more complex method to use if you need to finance a property. Your loan must be “non-recourse,” which means that you will not be held liable if the loan defaults. However, many lenders will refuse to make such loans.
If you obtain financing, only your down payment and principal are tax-deductible. Taxes continue to be levied on the financed portion of the property.
The same rules apply to self-directed IRAs as they do to traditional IRAs. You cannot withdraw funds until you reach the age of 59 1/2, and you must begin starting funds at the age of 70 1/2.
2. Hold Properties for a Minimum of One Year
Holding a property for at least one year is one of the simplest ways to reduce your tax burden.
If you’re a house flipper, you’re probably interested in buying and selling properties as quickly as possible. However, holding your properties for at least a year before selling can be more profitable.
The IRS considers you a “dealer” if you own an asset for less than a year and sell it for profit. Buying and selling short-term is regarded as a business. Additionally, because you are a business, you must pay FICA taxes—taxes designated for Medicare and Social Security.
Additionally, the property will be taxed as personal income rather than capital gains—which are significantly higher.
It is acceptable to sell one short-term rental property per year. However, if you sell two or more, you will undoubtedly be classified as a “dealer” for tax purposes and will therefore be subject to the higher personal income tax rate.
To avoid these taxes, hold your properties for more than a year before selling. If you’re flipping houses, you should be able to secure hard money loans that do not require repayment for 1-2 years.
If you find yourself in a financial bind, you can always rent out your fix-and-flip property before selling. Rent it to tenants and use the rental income to begin repaying your hard money loan. Assign a short-term lease to ensure that you can sell the property within two years.
As long as you own a property for at least a year, you can avoid FICA taxes and ensure that the sale is taxed at the lower capital gains rate.
Tax strategies for real estate investing
3. AVOID FEDERAL INCOME TAXES
As mentioned previously, the IRS will require you to pay FICA taxes if you are classified as a self-employed real estate investor. However, if you demonstrate “investment intent,” you can avoid these taxes. In other words, you are presenting to the IRS that you are attempting to raise capital for further investment projects and that this is not a routine business practice for you.
Among these investment opportunities are the following:
- Making improvements to a property
- Contributing toward the down payment on a long-term rental
These types of projects demonstrate to the IRS that you are committed to long-term investing and are not pursuing short-term gains for immediate business revenue.
Because establishing “investment intent” can be challenging, it is always prudent to consult with a tax attorney before implementing this strategy.
4. Tax Deferral Through a 1031 Exchange
Section 1031 of the tax code provides for a “like-kind exchange,” which allows for an indefinite delay in paying taxes on a property sale. All you have to do is use the proceeds from the sale to purchase a comparable property.
If you sell a property and earn $100,000 in profit, you can defer capital gains tax if you use the $100,000 to purchase another property (the $100,000 will be used as a down payment).
The following rules govern 1031 exchanges:
You must retain the services of an experienced intermediary to facilitate the transaction.
No later than 45 days after the sale of the original property, you must provide the intermediary with a list of potential replacement properties.
Within 180 days of selling the original property, you must purchase a qualifying replacement property.
The replacement property’s value must be equal to or greater than the value of the original property.
The original and replacement properties must be rental properties; neither may be used as a primary residence. In an ideal world, you could live in the replacement property for the remainder of your years and earn money by renting it to tenants. You would never be subject to capital gains tax.
5. Payment Plan
What if you profit from a sale but do not wish to use the proceeds to purchase another property? In that case, you would be required to pay capital gains tax and may face increased income tax.
Confident investors prefer seller financing when selling a property. With seller financing, you make a loan to the buyer of your property.
You will be taxed on the buyer’s down payment and principal (closing costs) but not on capital gains, as you did not receive the entire amount upfront. Rather than that, the buyer will pay you the remaining balance over time. Additionally, you earn interest from the buyer, making seller financing extremely profitable.
Naturally, seller financing is extremely risky. If the buyer defaults, the foreclosure will fall on you, as you retain a portion—if not the entirety—of the property’s equity.
Ensure that you thoroughly vet the buyer before offering seller financing to them. Additionally, it is prudent, to begin with, a lease-purchase agreement. The buyer starts as a renter, and a portion of their rent is applied toward the down payment on the home. You can transfer the property and sign a mortgage note once the buyer has paid a specified amount toward the down payment.
6. Mortgage Interest Can Be Deducted
Numerous expenses associated with real estate like Blue World City Project are tax-deductible. The following are some of the tax deductions available for real estate:
- Mortgage protection insurance
- Insurance coverage for your home
- Taxation of real estate
- Fees for property management
- Advertisement costs
- Fees for legal services
- Costs of maintenance
- Expenses associated with the home office
- Business travel expenses
The wonderful thing about these tax deductions is that you do not have to itemize your premises to claim them. You may claim both the standard deduction and deductions for a number of the expenses as mentioned above. Claiming these deductions can result in a significant reduction in your tax liability.
A word of advice: be truthful and avoid pushing it. If you’re going to purchase a personal laptop, avoid billing it as a business laptop. The IRS may become suspicious if there are an excessive number of questionable expenses, prompting them to conduct an audit.
7. Deduction of 20% for Pass-Through Income
Small business owners are eligible to deduct an additional 20% of their net business income. It is referred to as the 20% pass-through deduction. Because this tax deduction is intended for small businesses, income limits apply to $315,000 for married couples and $157,000 for single filers.
If you’re unsure whether you can claim this deduction, it may be beneficial to consult a tax professional.
8. Take Advantage of the Depreciation Deduction
Natural deterioration and wear and tear cause properties to depreciate. As a result, the IRS permits you to deduct the cost of each of your investment properties.
The IRS establishes a residential building’s lifespan at 27.5 years to allow you to deduct 1/27.5th of the property’s value each year for the first 27.5 years.
For instance, if your property is valued at $500,000, you can claim an $18,181 tax deduction for the first 27.5 years that you own it. (27.5 / 500,000)
Additionally, you can depreciate appliances and fixtures over 15 years, as well as property improvements. Thus, if you spend $5,000 on renovations, you can claim an annual deduction of $181 for 27.5 years. (27.5 / 5,000)
There is one significant caveat: if you claim depreciation, you may also owe taxes on depreciation recapture if you profitably sell the property. It is because the IRS requires repayment of the taxes avoided through depreciation claims.
You can avoid depreciation if you sell the property at a loss or do not sell it at all.
As a result, you may want to claim depreciation only on long-term holding properties.
9. Take Out a Loan Against Your Home Equity
Have you amassed a substantial amount of equity in a property? You can use the equity in your property to fund another real estate investment.
Confident investors may elect to sell the property and use the proceeds to finance a new investment—but this will likely result in capital gains tax. When you borrow against your home equity, you retain ownership, avoid capital gains taxes, and earn income to finance a new investment.
The majority of lenders will allow you to withdraw between 80 and 85 percent of your home equity. While there is some risk involved with losing the equity in the property and accruing additional debt, we can mitigate this risk by renting the property to tenants. Rent income can be used to repay the equity loan on the property.
How to minimize your paycheck’s tax burden
10. Compile a List of All Expenses
As you may have guessed, developing a tax strategy becomes more difficult when you don’t keep track of all your real estate expenses. Maintain meticulous records of all your costs, even more so if you intend to claim tax deductions.
Numerous real estate apps are available to assist you in keeping track of your expenses and even preparing for your annual tax filing. Ensure that you incorporate at least one of these apps into your real estate investment toolkit.
Real Estate Is Passing Away
What happens tax-wise if you die while owning real estate?
If you own property at the time of your death, the property’s “original basis” vanishes. In other words, the original purchase price of the property is irrelevant. Furthermore, your heirs are not required to pay capital gains taxes on the property.
Immediately following your death, your property will be reassessed and assigned a new market value. If your heirs choose to sell the property, they are not required to pay capital gains on any profit realized.
Assume you paid $300,000 for the property at the time of purchase. When a person dies, their property is appraised and assigned a value of $500,000. The property is sold for $550,000 by your heirs.
Under normal circumstances, $250,001 would be subject to capital gains tax. However, not if you died. Your heirs are not required to pay capital gains on the $550,000 profit.
If you are wealthy, your heirs may be subject to estate tax—only the first $11.8 million of your estate is tax-free. Otherwise, your heirs will face little tax liability, mainly if you have fully financed your properties.
Summary
You can increase your real estate profits if you learn how to minimize your investment’s tax liability. There are ten strategies for improving your real estate tax savings: 1) Invest in real estate through a self-directed IRA. 2) Maintain properties for more than a year 3) Avoid FICA taxes 4) Taxes can be deferred through a 1031 exchange. 5) Take advantage of installment sales 6) Deduct mortgage interest and other mortgage-related expenses 7) Take advantage of the 20% pass-through deduction 8) Make depreciation claims 9) Borrow against the equity in your home 10) Compile a list of all real estate expenses. Do you have any questions about what to do with your properties once you retire? If you retain your properties, your heirs will not be subject to capital gains tax if they sell at a profit. Consider reducing the size of your estate to less than $11.8 million if you wish to save your heirs from paying the estate tax.
