6 Ways to Stack Tax Savings on Real Estate Investments
Nov 10, 2017
I love taxes!
That's right... I said it. I love taxes. Taxes are our government's way of shaping the way Americans invest their money. Our government wants to invest in green energy and oil. How do they do it? Offer tax credits for green energy and oil investing. Our government wants to promote small business and entrepreneurship. How do they do it? Provide tax advantages for small business and entrepreneurs (did you know you can claim up to $5,000 in start-up costs without a statement? IRS). Our government wants to build quality housing for the lower and middle class to meet the demand of population growth. How do they do it? Tax credits for low-income housing development and unbelievable tax benefits for real estate investing.
If you're asking yourself "If the government wants to build low-income housing, why don't they just do it themselves?" Consider ventures such as Hooverville during the great depression and "projects" in low-income areas and how terrible those turned out.
For the novice investor, this article is going to OPEN YOUR EYES to the benefits of real estate investing.
When most people think about real estate investing, they think about appreciation. Appreciation is the increase in value of a real estate property as a result of the increase in the U.S. housing market. With the exception of the crash in 2008, the U.S. housing market has beat out the S&P in average rates of return almost every year. Rates of return are also localized and relative to specific areas. Many investors have made millions by investing in heavily appreciating areas based on things like gentrification, proximity to growing industry, or proximity to a geographically-constrained city. This all sounds great right? Well we don't even CONSIDER appreciation when we calculate our rates of return on turn-key investments. Appreciation is ICING ON THE TOP. The TRUE value in real estate investing is tax savings.
At ADPI we are not going to promise to make you millions overnight (a lot of BullS##T companies will). We will help you create WEALTH through wise real estate investments.
Back to why I LOVE taxes... here are 6 ways to stack tax savings on real estate investments.
- Deductions. As a real estate investor, you can deduct expenses in areas of your life that cross over with your real estate investments. These deductions can include your cell phone bill, your home office, your internet bill and your vehicle use. What this means is that when you file for taxes, work with your CPA to determine what percentage you use the aforementioned items for business. Once you determine that percentage, you can write off that percentage of the cost of those items and deduct that total from your taxable income - ultimately increasing your tax return. Also understand that many of your expenses associated with a real estate investment are tax deductible. These expenses include, mortgage interest, repairs, property taxes, and (for investments only) your home insurance premiums.
- Depreciation. Depreciation is a deduction taken on materials that break down, but not all in one year. For residential real estate, even though your property will appreciate in value, the IRS allows your to consider it a DEPRECIATING ASSET. Crazy right? That's because the government WANTS you to invest in real estate. The IRS has determined that the deductible life of a piece of residential real estate is 27.5 years, meaning that you are able to deduct the value of your building over that length of time. So, if you purchase an investment property for $200,000, you can deduct $7,272.72 every year (you can front-load depreciation through the implementation of a chattel appraisal, but we won't talk about that here). If you are in a 25% tax bracket, that means you can deduct that $7.2k - making you an extra $1.8k on your tax return. Now... things aren't quite that simple. If your total deductions exceed your earned income on your rental property, you would need to qualify as an active investor in order to deduct up to $25,000 from your W2 income. Talk to your CPA, take our course, or ask questions on our Facebook group to learn more.
- No Self-employment or FICA tax. The income you receive on rents is not taxed as "earned income" and therefore not subject to a major tax that most Americans pay - FICA / Self-employment tax. The current rate is 15.3%. If you currently have a W2 job, your and your employer split that 15.3% payment. If you are self-employed, you have to cover the entirety of the 15.3%. Luckily for us - we DON'T have to pay that tax for real estate investments.
- "Tax Free" refinances or HELOCs. Once you build equity in your real estate investment, you have the option of taking out a Home Equity Line of Credit (HELOC) or a cash-out refinance loan. What does that mean? OK... let's say you hold your investment property for two years. Your tenants have paid off $15,000 in principal (the mortgage payment - interest, insurance, and taxes) and your property has appreciated by $25,000. You now have $40,000 in equity. Lenders vary, but most will allow you to pull out 80% of that equity (before 2008 it was 100%). You can now either refinance your house and take out $32,000 in TAX FREE CASH or establish a HELOC for $32,000. You can use that money to pay off debt or purchase another investment property. Check out our blog post for more information on HELOCs.
- Expense Travel. There are three rules of thumb for classifying something as a business expense. A) the expense must have a business purpose and the primary reason for spending money was for business. B) The expense must be customary and usual within the industry, including the amount and frequency. C) The expense must be necessary with the purpose being to make more money for the business. These three rules are EASY to accomplish when traveling for real estate investing. Thinking of investing in a vacation rental property? Take an expensed "business trip" to go visit! Do you travel home frequently? Why not invest in a rental property there - turning your home visits into a business expense. This same principle applies to family employment, nights out, and vacations. The possibilities with real estate are endless!
- 1031 Exchanges. A 1031 or "like-kind" exchange allows an individual to sell an asset and carry their gains forward into a new, higher priced asset. You can 1031 exchange cattle, ie. selling an old, dumb cow for a younger better cow. You can do the same thing with real estate! Using 1031 exchanges you can continually upgrade your properties without EVER PAYING TAXES. The general progression for savvy investors generally starts with a single family rental and ends with a large commercial property that racks in tons of cash flow - having never paid taxes on your gains. Although this is a monumental opportunity for investors, it is not easy to accomplish. Talk with your CPA and find a good team before you attempt a 1031 exchange.
In summary, get on the WINNING side of taxes. This article only touched on a few of the benefits afforded to real estate investors. There is endless opportunity out there when it comes to real estate. Sign up for our course and reach out to us on our Facebook page to learn more.
Authored by: Jon Licht
West Coast Chief, ADPI