Investing in real estate can be extremely lucrative. Successful investors can over time amass large portfolios of properties that spin off a passive monthly cash flow as rents are collected or make a quick profit by flipping properties. Making the most of the gains does require an extensive knowledge of the applicable tax laws. Real estate investors enjoy some tax benefits that most W2 or 1099 employees do not have. Having an understanding of the tax laws is crucial not just during tax filing season, but year-round so investors stay cognizant of how the tax breaks can be used to maximize profits while making investment decisions. Most of the tax breaks fall into one of three main categories: depreciation, deductions, and capital gains. Having at least a brief understanding of each of these can help the rookie investor map out a strategy as they get started.
The IRS lets property owners deduct the cost of buying and improving a property over its useful life, thus lowering your table income, and easing your overall tax burden. Most properties can be depreciated over a 27.5-year period, with some improvements or renovations on a faster schedule. Keeping accurate records of closing docs and bank statements will be crucial come tax, so property owners make sure to stay organized.
Depreciation is not the only item that can be deducted. Pretty much all expenses related to your properties can be dedicated as well, including mortgage interest, maintenance, management expenses, and insurance. Again, staying organized is crucial so these expenses can be accurately accounted for come tax time and during an audit.
Just like with any other asset, when a property is flipped for a profit, regardless of how long it has been owned, the IRS will want to collect capital gains tax on the profits. Investors can delay accruing these taxes if the profits are, within six months, rolled over into a new property. This allows investors to delay paying taxes in perpetuity on any capital gains that are accrued, provided they keep buying new properties with their profits. This can save an investor an enormous amount of money over their career.
For those making real estate investing a career, there is one other big tax advantage for them that is not available to the side hustler with a full-time job elsewhere. Those who can document and prove that they are working 2,000 hours a year or more in real estate, and not working 2,000 or more at any other job can qualify as a Real Estate Professional with the IRS. This designation is not easy to get, you must legitimately be working that many hours, but it allows you to deduct passive activity losses to offset non passive income elsewhere. Most investors can only claim passive losses against passive income derived from that passive activity only. Those with the REP designation can deduct losses from any income they have, which can substantially lower the overall tax burden. As you can see, the tax situation gets quite complex and making an error, even an error by omission can get costly. Most investors will need to obtain the services of a tax professional to complete their tax return every year.
Cityfunds is a new investing product that will allow the retail investor to passively enjoy many of the benefits of residential real estate investing without actively investing themselves. Until now, the only real way to get involved with residential real estate was to purchase a property of your own. Cityfunds pools investment dollars from a group of investors to invest in residential real estate in cities around the country, drastically reducing the barriers to entry in this lucrative market.