Real Estate Investments: The Tax Season Benefits

Fortunately, the Asheville Citizen-Times notes, the government is smart enough to realize that private property owners make better landlords than it does.

When you own real estate and make it available to renters, you perform a very valuable service for your community, and the government rewards you with some impressive tax benefits.

Even with recent tax law changes, investing in real estate is still one of the best, if not the best, financial move you can make. But it’s not the gravy train it was before the 1986 tax law revisions.

Back in the heyday, people used real estate to shelter incomes in excess of a million dollars a year and paid no federal income tax. Sounds like a good use of a mortgage loan to us.

Unfortunately, those glory days are over, but the remaining benefits make real estate one of the most lucrative assets you can own.

Look at your next paycheck stub and you’ll notice a deduction for Federal Insurance Contributions Act. Not only do you pay this tax, but your employer must match, too. Earned income is subjected to the FICA tax, and there’s no way around it until your income surpasses a certain amount. Both the tax rate and the amount subject to the tax have been steadily rising.

On the other hand, rents you collect from real estate, no matter how large they get, are considered “passive income” and are exempt from both employee and employer share of FICA taxes. Just this tax break alone is a tremendous reason to own real estate.

You can also deduct all expenses associated with investment real estate to reduce the amount that is taxable. You can deduct things like interest expense, property tax, management fees, homeowner’s insurance, repairs, homeowner’s association dues, utilities, legal and accounting fees, etc.

Moreover, you even get to deduct a portion of the purchase price you paid for the property each year in the form of depreciation.

If, after taking all of the allowed deductions, your income is zero or you show a loss on paper, you will pay no ordinary income tax and, under these circumstances, may be able to apply some or all of your loss to offset taxes on your salary.

The mortgage interest deduction plays an important role, especially when you’re just getting started and cash flow is tight. Most investors finance as much as possible in the beginning; interest is most likely the largest expense.

Over time as the home mortgages are paid down and the rents increase, the interest deductions will decline but the cash flow will increase. When the mortgage is paid off, although there may be some tax to pay, investors will get to keep a substantial part of the income because they won’t pay interest.

There are so many additional tax benefits to real estate it’s hard to do justice to all of them. There are ways to sell properties and defer taxes on the profits if you if you reinvest them in additional properties.

Even if you don’t reinvest them, if you have owned the properties for at least a year, the profits are taxed at a very favorable capital gains rate, which can be less than half the rate for ordinary income.

Under the current Internal Revenue Code, you can avoid paying taxes altogether on profits up to $250,000 from the sale of your personal residence and can do it again every two years.

SOURCE: Asheville Citizen-Times