Finding ways to manage your tax burden as an investor is never an easy task. No matter how much you research or how much you strategize, you are likely to find the complexities of managing your tax burden an ever-shifting obligation. It gets more complex if your business involves real estate investments, and while there are a lot of opportunities in real estate, tax planning is essential. If you know how to operate efficiently, you can more easily minimize your tax burden. Read on for more practical strategies, and find out how tax planning for real estate investors works.
Remember That Your Home Is A Tax Shelter
The house you live in has a few tax benefits from the moment you make it your home or primary residence. This is vital information because it is possible to occupy houses in the process of improving them, which provides you with the opportunity to deduct mortgage interest. In some areas, it even provides you with a property tax credit. There are limitations to the use of this strategy, so unless your improvements will take a long period of time, it might not work for every situation. Even so, the opportunity to invest in your own permanent home as a tax haven is always available when you work in real estate.Remember, when it comes to your home, the IRS does not tax the first $250,000 of the profit if you are single, and the benefit doubles for married couples. This alone makes improving homes and moving regularly a potentially lucrative investment strategy.
Choose Your Investment Strategy Carefully
This might seem like general advice, but it really isn’t. While it’s always true that investments require careful decision-making, strategic investment is different when you are trying to minimize your tax obligations. For starters, remember that the timing of your investment and subsequent sale can affect the tax year that it falls into. This means that you might benefit from holding properties a little longer than you otherwise might if it pushes the tax obligations to the next quarter or the next year. This can help you control the amount you must allocate in taxes each quarter.Certain kinds of investments are also incentivized with tax breaks and other opportunities at the federal, state, and local level. By selecting investments that take advantage of these opportunities, you can easily shrink your tax burden while growing your investment portfolio.
This is also called a 1031 exchange. This means that if you are rolling the proceeds of one sale into another property, you can defer the tax payments on your profit from the sale. This is a really useful strategy, because you can continue rolling profits over in a chain, buying ever more expensive properties with the proceeds. You do have to break the chain to get your investment back, at which point you will be on the hook for the taxes. In the meantime, though, the 1031 exchange allows eligible investors to basically get a zero percent loan in the form of that tax deferral.
Business Tax Strategies
It’s important to remember that your real estate investment business is a business. The income taxes you pay on your profits use the same Schedule C form as an entrepreneur who, say, runs a convenience store. That means you have the opportunity to use the same strategies other small businesses use to minimize their tax burdens. That includes all of the following:
Itemized deductions for business expenses including home office space, technology expenses, marketing, and other related business expenses
State and local tax incentives aimed at small businesses and local investment
Tax deferral and payment programs designed for small businesses
Credits designed to spur business investment or to offset the cost of property taxes
If you have any family members working for the real estate business, you want to make sure you pay them, and these expenses will be able to be worked into your overall tax plan. This allows your family to get money out of the business as personal income, and it helps reduce the overall business tax burden that you face. As with any tax analysis, always speak with your tax advisor.
Last but not least, remember that depreciation is tax deductible. No set of tax strategies for real estate investors would be complete without pointing this out, either. Lost value on the property usually can’t be claimed as a tax write off until it is sold. When you make improvements on the property, though, it’s often possible to depreciate them, in which case you can deduct depreciation of their value from your taxes. This is a vital strategy for many real estate investors.Tax planning for real estate investors can be a difficult task, but with the right strategies, it is easy to gain control over your tax burden.Learn all about the tax implications of real estate crowdfunding in our free eBook before you start investing.
Real estate investments don’t work like any other form of investment business. They involve investing in physical properties at various stages of development. This distinction creates some unique opportunities for entrepreneurs and investors working in this industry. To get the most out of your investments, you need to understand how income from real estate investments can be earned beyond the simple act of buying and selling a home. You also need to understand how diversifying your real estate investment approach can bring you tax benefits, and which tax advantages are available for those looking to develop properties.
Diversifying Your Real Estate Income
There are two ways that most people move into real estate. Either you start by buying, improving, and selling properties or you start out as a landlord, taking care of rentals. Either way, it is a good idea to diversify your investments and to make use of both approaches. In terms of real estate investing and taxes, the income properties will create a steady cash flow that can be used to pay expenses like your contractors and your tax bills. The sales can then be used to increase your overall portfolio size and to create working capital for large investments.There are also often local incentives to provide certain types of housing or business space, especially if there are renewal or Renaissance zones in your city. Strategically taking advantage of development opportunities with those kinds of tax benefits can lower the tax obligations of your whole operation through the judicious use of one or two investment opportunities. Look for opportunities in all these areas:
Public-facing commercial real estate like restaurants and retail spaces
Industrial and professional spaces
Single family rentals
It’s also a good idea to look at the opportunities available through crowdfunding and other real estate investment platforms, since that is another way of receiving income from real estate investments with their own tax opportunities and complexities.
Like-kind exchanges, also known more formally as 1031 exchanges, have been a vital part of the real estate sector for years. They allow investors to defer capital gains taxes owed on the profits from a property sale into the purchase of a new property. This essentially provides an interest-free loan to the investor for the value of the taxes, which is then due when the new property is sold.The exciting thing about 1031 exchanges from a real estate investment point of view is the fact that they can be chained together. That makes them one of the most effective real estate investing tax strategies, because you can essentially continue the chain of like-kind exchanges as your portfolio grows, using the properties you are holding while they appreciate as rental income for cash flow while you wait to roll the property over to a larger investment. You will pay taxes on the rental income, but that can be managed through the use of tax programs and other deductions.
Business Expenses And Itemized Deductions
One of the reasons why it’s wise to go into the rental business as part of your tax strategy and part of your business plan is because of the opportunity to use the associated business expenses. From deducting mileage when you visit your properties to having the opportunity to count marketing expenses incurred while advertising vacancies, there are a number of opportunities that are easier to take advantage of when you have a regular day-to-day operation that is making a consistent income.
Understanding Internal Rate of Return
Internal rate of return is a measurement you can use to determine which of your investment opportunities are most likely to be the most lucrative. Its formula involves calculating the relationship between investment costs, net cash flow, and the time the investment will operate. It takes some research to calculate it correctly, but basically the higher the value, the better the investment opportunity.When using internal rate of return, it is important to know all of your tax liabilities and the available real estate investment tax deductions going into the calculation, because that knowledge is part of the calculation of your net income or profit. The lower the tax burden presented by that option, the more it will positively impact the internal rate of return.
Putting It All Together
The question becomes, with all this knowledge about the ins and outs of real estate investment, what do investors need to do to be successful? To put it all into an easy to manage process, consider the following, a step-by-step checklist for investing:
Locate diverse opportunities that involve both rental income and sale income
Identify the available tax obligations and the deductions that exist to mitigate them
Identify other overhead and operating expenses
Calculate the term of the investments
Use these items to calculate your internal rate of return
Compare rates of return to find your best investments for the time being
It sounds simpler than it is, but having a clear guide is the best way to start organizing complex information. Make sure to learn all about the tax implications of real estate crowdfunding in our free eBook before you start investing.
Our friend and industry colleague Joe Stampone recently put together a great eBook on his top 7 real estate crowdfunding platforms. While we were excited and honored to be included, we wanted to share Joe’s post and eBook because it’s a great 3rd party view on the industry. I’d encourage you to not only take a look at the eBook, but also follow Joe’s blog if you’re interested in learning more about real estate from a true industry insider. We’re excited to work with Joe more in the future!
A few months ago I provided an overview of the various opportunities for real estate crowdfunding investors, however I didn’t dig into the specific platforms. In my latest eBook, I break down what I view as the top 7 real estate crowdfunding sites for investors. While there are 100’s of sites out there, the 7 I chose are established players, well-funded, operated by experienced real estate professionals, and sites I’d trust with my own money. This is by no means exhaustive, but a good starting point for any potential real estate investor.
Direct investing in cash flowing real estate should be part of any investors’ portfolio. However, a millennial who is an unaccredited investor with a few thousand dollars to invest has a much different investment objective than a high-net-worth individual who recently retired and has $1mm to invest.
Why I wrote this guide:
1. There are a lot of poorly run platforms funding risky deals and it’s impossible for the amateur real estate investor to identify the good ones.
2. There are several investment models and it’s challenging to determine which is right for you based on your investment objectives.
3. The space is evolving rapidly and there are new investment models that investors should be aware of.
In the guide, I break down each platform outlining what I like, my concerns, fees to investors, their underwriting process, and even fun facts.
There are 5 core investment models to choose from:
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You can read the rest of Joe’s post and download his ebook HERE.
Joe Stampone is the VP of Investments for Atlas Real Estate Partners. He also authors a popular blog, A Student of the Real Estate Game, a community of real estate professionals driven by a passion to be on the cutting edge and grow their careers through collaborative learning.