You’d be shocked at the number of ways that you can save on your real estate investment taxes. The tips below are proven methods that will save you on your taxes. They will allow you to pay the absolute least amount possible, each year. By the way, do not take this article as accounting advice! If you’ve got accounting questions, your accountant will be better suited for them. This article is simply meant to give you real methods of saving on your real estate investment taxes.
Hire an accountant that actually invests in properties themselves
The first thing you should do is hire a Certified Public Accountant, or, a CPA. Ideally, one in your local area. It’s not completely necessary that they be local; but it is preferred to have one that invests in real estate. Know now that hiring the wrong (or an inexperienced) accountant is going to cost you to pay more in taxes than any other mistake. If you’re successful in real estate, the cost of the accountant should be a drop in the bucket.
Now, how do you find the right CPA? Well, sometimes the answer is as easy as asking investors in your area who they use. However, some aren’t too keen on telling you just who that is. In that case, ask someone on your investing team, such as a realtor, a mortgage broker, or your closing attorney. There are also many real estate investing clubs that will give you some names for a CPA. Finding the right CPA is crucial, and it’s worth spending the effort to find a great one. If you’re having a tough time finding one that owns real estate, don’t stop. You’ll find one eventually. Keep researching and asking around. Persistence is key.
Be sure to separate your short term activities from the long term ones
Separate your earned income investments (house flips, assignments and renovations, and wholesales) from your actual rental income properties. You never want to get your rental income taxed as personal income. This is such an important tip, and make sure you follow it. Doing housing flips in your personal name and owning rental property in your personal name is going to cost you a whole lot of money when it comes tax time. Make sure that if you own rental properties in your personal name, that you set up another entity for your housing flips.
So, what type of entity should you create? There is not one solid answer to this question. There are a couple different entities, and the one you choose will be based on specific factors. In some cities, if you own a Limited Liability Company (LLC), you can be charged almost an extra three percent in franchise tax on the total value of its assets annually. Food for thought. Whereas other entities might be entirely exempt from that tax. How should you decide which entity to create? Well, that’s why you’re going to find an excellent CPA. This is who you’ll want to answer those questions and help you decide.
Get your organizational skills in check
Know right know that the Internal Revenue Service (IRS) does not look kindly upon the unorganized business owner. There is an endless list of business owners who were imprisoned, or are now desolate. There are many, many skills you’ll need in order to be successful in real estate, and one of them is organization. You’ve got to make sure the books are organized.
Make Quickbooks your new best friend; paper is outdated with accounting
Quickbooks is a household name among small business owners for documenting expenses an incomes into an organized system. Probably because it’s so useful, inexpensive, and easy to use. Investors who simply keep every receipt that they have, and bring them all to the CPA is not utilizing the creativity advantage that CPAs have when everything is documented digitally. Basically, if the information is digital, the accountant can perform to their highest potential.
Most of the time, you’ll discover that you’ve mistakenly combined personal income and expenses with business transactions in the exact same accounts. Huge mistake. Every single business deposit and bill should through bank accounts and credit cards that are used solely for business.
Actually, some banks like American Express and Bank of America are connected with Quickbooks so that all you have to do is click a button to import the transactions. How cool is that? If you don’t have bank accounts or credit cards separating your business from personal transactions, you’re in for a very unpleasant surprise. Doing os is going to save you hours upon hours of time organizing the books, and, a lot of money on a bookkeeper. Usually, you’ll pay a bookkeeper and an accountant by the hour. How much time do you think its taking them to go personally through the entire quarter of receipts? Weeks. You’re paying them far more money than you need to; and, wasting a lot of your time as well.
When you keep your business organized, only then can you see specifically what is going on with your business in terms of profits. Quickbooks has an excellent Profit & Loss calculator that they do for you. And guess what? It’s pretty accurate. You’ll get to see clearly where most of your profit is coming from, and most of the time, you’ll be surprised. You may think the bulk of your profit has been coming from one place, and its really been coming another. When you see things like this, you may realize you should dedicate more time to one side of your business than the other. All of this can be discovered simply by staying organized! Who knew?
Add some rentals investments to your portfolio
A great way to save on taxes is owning rental properties. The reason behind this is that the IRS allows you to factor in depreciation. This means that you can depreciate the amount you bought the property for, and subtract it rom the value of the land over a certain number of years. This can serve as a very large expense on your tax return.
Now, if you’re renting them out, you can even depreciate maintenance. Basically, the tax can sometimes get all the way down to zero, where you’re not even paying tax on the rental income. What’s more, is that if the property increases in value, you’re also not going to be paying tax on the appreciation of it. It’s so surprising to people, but owning rental property is one of the best ways to earn money in the country regarding tax advantages!
Copy the 1% of the world
The wealthiest people in the world pay a whole lot of money in taxes. Actually, the wealthiest people in the country pay well over half of the total revenue in taxes. But, they actually pay less than the middle-class. This is because most wealthy people earn at least a little—sometimes all—of their income through investments rather than through 1099s or W2s which you get by working for other people.
Rental property is one of those investments that allow the rich to earn a heck of a lot of money, but pay low taxes. Another great way to earn money like the uber successful is with a 1031 exchange. The wealthiest people in the US make their income from investments. Therefore, follow them. Earn your income from investments!
Remember you can potentially deduct taxes
As a rental property owner, you are able to deduct nearly all the expenses you’ll pay to manage your property. Everything from the mortgage interest you pay on the loan all the way down to the paper you buy for your printer.
Of course, you might should not qualify this as a “huge benefit” of rental property investing because you are still having to spend the money on those items. Who cares if you can deduct the cost of paper because you own a rental property — because if you didn’t have the rental, you wouldn’t have spent the money on the paper in the first place.
However, where this deduction can come in handy are on the areas of your life that are shared with non-real estate activities. For example, if you have a home office, you may be able to deduct a portion of your home expenses (fax machine, internet bill, cell phone bill, mortgage interest, home repairs, etc.) equal to the portion that your office takes up in your house.
Or if you need to drive up to check on your rental property and swing by the grocery store on the way back, you might be able to deduct the cost of your trip using the IRS standard mileage deduction. The benefit of this, of course, is that it’s not like you wouldn’t have those bills anyway without a rental, so if you itemize those deductions carefully, you may be able to save significantly at tax time. You needed a cell phone, you needed that office, you needed that trip to the grocery store. Only now, you might be able to deduct some of them because of the business use.
Things like meals, travel, and other similar expenses may also be able to be deducted, but don’t assume you can go to Disney World with your family and write off the whole trip because you spent a few hours looking at real estate. That’s called “cheating,” and you’ll likely find yourself in some hot water if you ever get audited. However, just like your home office deduction, perhaps you can deduct a portion of your expenses to help offset the costs some.
Even better, if the proceeds from the refinance was used for your primary home or for another investment property, you may be able to deduct the interest paid on that loan! So, not only can you borrow the money tax free, but you can possibly lessen your tax bill at the end of the year for doing so.
The 1031 exchange, named for Section 1031 of the Internal Revenue Code, allows investors to defer taxes by selling one investment property and using the equity to purchase another property or properties of equal or greater value. This exchange must occur within a specified period of time. Although a 1031 exchange can broadly include various types of property, the vast majority of transactions relate to real estate.
The ability to borrow will also depend on a borrower’s credit score, their existing debt-to-equity ratio, and their debt-to-income ratio. While this strategy is a bit riskier, for those able to handle the additional debt, it can help build wealth without having to enter into a 1031 exchange or sell a property.
Borrowing Against Home Equity
Investors who have built up sizable equity in either their personal home or investment property may simply choose to refinance their properties and pull out equity to make additional investments, improve the home, or for other purposes. Regulations vary from state to state.
Last word about taxes
Taxes are inevitable. But unlike the rest of the working world, the IRS actually seems to like real estate investors, so the sting is not quite as sharp. The US tax code is incredibly complex, and every strategy has rules that must be followed, exemptions that are allowed, loopholes that only the rich seem to know about, and penalties if not performed correctly. For this reason, it is absolutely imperative that you talk with an investor-savvy CPA when plotting your tax strategy. And remember, as you build wealth, a good CPA will save you more money than they cost. And they might just keep you out of jail!
Investing in real estate continues to be one of the best ways to build wealth and cut taxes. Benefits include the ability to recover the cost of income-producing property through depreciation, to use 1031 exchanges to defer profits from real estate investments, and borrow against real estate equity to make additional investments or for other purposes. Additionally, homeowners can benefit from the personal-residence exemption, which shields profits on the sale of a personal residence from capital gains taxes, as well as the deduction for mortgage interest.