4 Ways to Strengthen Your Tax Strategy as a Real Estate Investor (2024)

Investing in real estate can be an excellent way to earn passive income. Since properties tend to appreciate in value, the equity you gain may be significant. Renting your properties will also produce net income while helping to pay off any mortgages you take out.

You don’t even have to dive in head first, given options like real estate investment trusts. REITs allow you to play the market from the sidelines – much like you do with stocks and bonds.

But the IRS won’t let you earn those profits scot-free, meaning tax-free. Yep, there are taxes to pay, and how much you’ll send to the government will depend on your real estate portfolio. Your strategy will also influence any tax implications from real estate investments.

The IRS may have rules, but it wants to encourage you to invest because it stimulates the economy. Here are four ways to strengthen your tax strategy while staying within the legal lines.

1. Deduct Everything You Can

Tax Deduction
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With any income, the goal is to reduce your tax burden so you’ll keep more of your earnings. An example is having your employer deduct your out-of-pocket insurance premiums and 401(k) contributions before income taxes. But when it comes to real estate, your allowable deductions expand.

As you already know, you can subtract your annual mortgage interest up to certain limits. Although this amount can run into the thousands, your deductions don’t end there. You can include property taxes, insurance, and homeowners association fees.

Don’t forget your maintenance costs, including upgrades and improvements. Yes, you can deduct the fertilizer you apply to the lawns or the costs of hiring a landscaper.

Beyond maintenance expenses, you may have property management, legal, and business-related costs. This overhead usually applies if you rent and flip your real estate. However, legal and accounting costs may come into play if you need property-related advice.

Say you need to sell an inherited home or learn how to use the IRS’s home office deduction. Legal fees, online course expenses, and purchased software can all become deductions.

Maximizing your allowable deductions lets you exert more influence over the gains you earn from owning real estate. As LifestyleInvestor expert Justin Donald notes, “One rule of thumb is to build assets that the government encourages with tax incentives, such as real estate.

Rather than saving, where the money will be taxed more heavily – the rich invest their money in these investments. This allows them to accumulate wealth faster by retaining more control over it.”

2. Own Your Properties Longer

Own Your Properties Longer
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One of the benefits of working for an employer is that you split the costs of Social Security and Medicare taxes. You pay 7.65% of your income, while your employer pays the other half. When you’re self-employed, you owe the entire 15.3%. Anyone who fills out Schedule C and SE each year knows the pain.

When you flip multiple homes a year, the IRS may flag your gains as self-employed income. You’ll pay income taxes according to your tax bracket – and the 15.3% self-employment rate. Say you earn $50,000 from a day job and $30,000 from flipping houses.

The $30,000 is taxed as self-employment and is added to your overall income. The additional $30,000 could push you into a higher tax bracket, resulting in a larger-than-expected check to Uncle Sam.

One way to avoid this is to hold onto your real estate investments for longer than a year. This strategy doesn’t mean you can’t flip. Maybe you rent the homes after you renovate them so you can cover your costs and boost cash flow. By holding off, you’ll pay long-term capital gains taxes instead. The rate will depend on several factors, including whether you claimed depreciation expenses.

Furthermore, you can reduce your capital gains outlay by deducting the cost of renovations, repairs, and closing costs, among other things. You can also reinvest your profits in another similar property, known as a 1031 exchange.

3. Take Out a Home Equity Loan

Home Equity Loan
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Say you need to tap into a property’s equity. You might want the cash to expand your investment portfolio. Or you need the money to upgrade your primary residence and fund your lifestyle. You could sell the property, but then you’d be stuck paying capital gains.

An alternative to selling is to get a home equity loan. Doing so lets you access most of the property’s equity to pay for your next project or everyday needs. You’ll avoid capital gains taxes and may be able to cover the monthly loan payments with rental income.

Of course, you’ll want to consider the cost of borrowing and your current debt-to-income ratio. You don’t want to borrow more than you can handle.

Essentially, a home equity loan is a mortgage. If you already have a loan, you’ll add a second one. This may not be an issue if the property is a hot rental with a steady cash flow. Just remember there can be more risk involved when you take this route.

Calculate whether you can comfortably pay what you owe before you sign the paperwork.

4. Make a Property Your Primary Residence

Primary Residence
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Variety can sometimes add spice to your life. In terms of owning real estate, it may also help you avoid taxes on capital gains. As long as you’re willing to change homes every two years, you could delay paying capital gains indefinitely.

The IRS will allow you to exclude as much as $250,000 in capital gains on the sale of your primary residence when you file as a single taxpayer. This amount increases to $500,000 if you file jointly as a married couple.

The caveat is you must have lived in the home for at least two years. And the property must be your primary residence, not a second home or a rental. However, nothing is stopping you from selling your primary residence for a profit after two years and moving on to the next one.

All or most of the capital gains you make from the sale can be taxed at 0%. What you paid for the property and any improvements will influence your capital gains. So will real estate market prices at the time of sale.

Your capital gains could exceed the exclusion limits if property values have increased significantly in a short amount of time. But in most cases, avoiding capital gains on up to $500,000 in profits is a reasonable expectation.

Strengthening Your Real Estate Tax Strategy

Real Estate Tax Strategy
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It’s no secret the majority of people accumulate wealth through real estate. Whether it’s by owning homes or renting properties, there are multiple ways to make money. The government, however, has a stake in a piece of your investment pie.

Reducing your tax burden lets you keep more of what you earn while growing your portfolio. By knowing what rules apply to the real estate game, you can use smart strategies to score.