Save More on Real Estate Taxes!

Hey everyone, I’m Bette Hochberger, CPA, CGMA. When investing in real estate, maximizing tax savings can significantly boost your return on investment. Understanding and leveraging the various tax benefits available can help you reduce your tax burden and increase profitability. 

Here’s a guide to some key strategies that can help you maximize your real estate tax savings.

Depreciation Deductions

One of the most effective ways (and my personal favorite) to save on taxes is through depreciation deductions. Depreciation allows you to deduct the cost of wear and tear on your property over time. Even though your property might be appreciating in value, the IRS permits you to claim depreciation on the building’s structure and certain improvements. 

Residential properties are typically depreciated over 27.5 years, while commercial properties are depreciated over 39 years. By using methods like cost segregation studies, you can accelerate depreciation, allowing you to front-load these deductions and realize more savings in the earlier years of ownership.

1031 Exchanges

Another powerful strategy for real estate investors is the 1031 exchange, which allows you to defer capital gains taxes when you sell a property by reinvesting the proceeds into a similar kind of property. 

To qualify, the replacement property must be of equal or greater value, and you must adhere to specific timelines, such as the 45-day identification period and the 180-day closing period. By utilizing 1031 exchanges strategically, you can grow your investments while deferring taxes indefinitely, thereby maximizing your tax savings.

Cost Segregation

Cost segregation is a tax planning strategy that involves identifying and reclassifying personal property assets to shorten the depreciation time for taxation purposes. This approach can result in substantial immediate tax savings by accelerating depreciation and increasing deductions in the early years of property ownership. 

Eligible assets might include items like landscaping, electrical systems, and interior improvements. Conducting a cost segregation study on your properties is a proactive way to ensure you are taking full advantage of available depreciation deductions.

Interest Deductions

Interest on loans taken out for investment properties often qualifies as a tax-deductible expense. This includes mortgage interest, interest on loans for property improvements, and even, in some cases, interest on credit cards used for property-related expenses. 

Mortgage interest is deductible for both primary and secondary residences, while interest on investment loans can help offset rental income and lower your taxable income. Keeping detailed records of all interest payments related to your real estate investments is crucial to capturing all possible deductions.

Qualified Business Income (QBI) Deduction

Real estate investors who operate as pass-through entities—such as LLCs, S-Corps, or sole proprietorships—may qualify for the Qualified Business Income (QBI) deduction. This deduction allows you to write off up to 20% of your qualified business income, which can significantly reduce your taxable income. 

To maximize the QBI deduction, it’s important to make sure that your rental activity is classified as a trade or business under IRS rules and to carefully manage income and expenses. Consulting with a tax professional such as myself can help ensure your real estate activities qualify for this valuable deduction.

Tax-Advantaged Retirement Accounts

Investing in real estate through tax-advantaged retirement accounts, such as a Self-Directed IRA or Solo 401(k), can offer significant tax savings. These accounts allow your investments to grow either tax-deferred or tax-free, depending on the type of account. 

For example, in tax-deferred accounts, any gains, rental income, or appreciation are not taxed until you withdraw the funds. In contrast, Roth accounts offer the advantage of tax-free withdrawals in retirement. Leveraging these accounts can help you build wealth while minimizing your current tax liabilities.

Rental Property Losses

If your rental property expenses exceed your rental income, you may be able to deduct these losses from your other income. To qualify for up to $25,000 in rental losses, you must actively participate in managing the property. 

However, if real estate is your primary business, achieving real estate professional status can increase your ability to deduct rental losses. Understanding the rules and thresholds for claiming rental property losses is key to maximizing this deduction and reducing your overall tax burden.

State and Local Tax Deductions

State and local tax (SALT) deductions are another opportunity to save on taxes. You can deduct property taxes, and in some cases, local income or sales taxes related to your real estate investments. 

While property taxes are deductible for both investment and personal properties, it’s important to keep in mind the $10,000 cap on SALT deductions if you itemize your federal return. Careful planning of your deductions can help you get the most out of this tax-saving opportunity.

Maximizing real estate tax savings requires strategic planning and a deep understanding of the tax code. But by leveraging these strategies, you can reduce your tax liability and increase the profitability of your real estate investments. As tax laws change and your portfolio grows, consult with a tax professional to make sure that you’re taking full advantage of all available deductions and credits!

I hope you all learned something new today, and as always, stay safe, and I will see you next time!