The first tax benefit of real estate investing is the ability to deduct qualifying expenses. You get to deduct any expense directly related to the management and maintenance of the property.
Some common expenses include property taxes, property insurance, mortgage interest, repair and maintenance costs, property management fees, advertising, and accounting fees. All of these expenses can offset the rental income and reduce your taxable income. Essentially, real estate investment can pay for itself when rental income exceeds expenses and may even give you some extra income in your pocket each month.
Just like you can deduct qualifying expenses, you can also depreciate your investment property. Qualifying real estate investments are usually depreciated over 39 years on a tax return. As a result, this can further reduce your taxable income.
It’s worth keeping in mind that land itself doesn’t depreciate and depreciation on the real estate investment reduces your cost basis. When you go to sell the property, you will have a lower cost basis, potentially resulting in a higher gain on the sale. However, long-term gains are taxed at more favorable rates.
There are two ways a real estate investment property can be reported. The first way is on a Schedule E on the individual tax return. The other way is by setting up a separate LLC or Partnership that holds all the real estate investment information.
Setting up a separate company to house your real estate investment can give way to a special pass-through deduction, known as the Qualified Business Income Deduction. The Qualified Business Income Deduction allows you to deduct up to 20% of qualifying income through 2025. There are some limitations so be sure to consult your tax advisor for further details.
Another key tax benefit of real estate investing is the bypassing of self-employment taxes. Real estate investments are usually passive income, making the income received non-taxable as self-employment income.
The income you receive from real estate investments is not earned income and therefore not subject to any self-employment taxes. If you accumulate enough real estate investments to generate a steady income, you may have the ability to focus solely on your real estate business to bring in a livable wage and avoid self-employment taxes altogether.
Real estate investing can be a great way to diversify your wealth portfolio. The tax benefits available for real estate investments can be great. With the housing market booming and a wide variety of people looking for rentals, now might be the right time for you to take the leap of faith. You don’t have to embark on this journey alone. Amberstone Consulting is available to consult you on any questions you may have relating to the tax benefits of real estate investing.
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