Smart Real Estate Investments

By on April 21, 2014
Smart Real Estate Investments

Investing in real estate can be a great way to generate income. Not only can real estate investment properties earn a profit, but they’re also treated favorably come tax time. If you’re a real estate investor, these tips will help to ensure that you’re taking advantage of all the tax breaks you’re entitled to when you file your return.

Organize Your Finances

If your income and expenses aren’t carefully documented, you could be missing out on opportunities to minimize your taxes and learn where your biggest profits are coming from. Many people aren’t meticulous by nature, so they wind up overlooking certain bookkeeping tasks—like logging deductible expenses or always using a business account for professional purchases (or income). However, keeping track of your finances is a critical part of owning a business. Solid accounting does more than just give your real estate investments a boost—it also protects you from being penalized by the IRS for not keeping accurate financial records.

Rent Your Property

Rental properties can be some of the best real estate investments—not only because of their opportunity for profit, but because of the tax advantages. When you purchase a rental property, you can depreciate the home (although not the land itself) over 27.5 years. To get a better idea of the value, consider the following example.

Say you purchased a rental property in California for $400,000. If the lot of land is valued at $100,000, you would be able to claim tax deductions based on the $300,000 value of the home. To calculate your annual tax deduction amount, divide the home value by 27.5 (the number of years over which it can be depreciated). The result? An annual deduction of about $10,909.

Sell on a Rent-to-Own Basis

If you’re in the habit of purchasing property to sell, consider selling on a rent-to-own basis. Why? Renting out a property for a year prior to selling could allow your net profits on the sale to be taxed at a capital gains rate (rather than your income tax rate) which could mean considerable savings.

Consider 1031 Exchanges

When you sell your rental property, you stand to incur additional tax benefits through a 1031 exchange, which means you use sale profits to purchase a new property. In certain cases, a 1031 exchange could allow your profits escape taxation entirely.

Separate Short- and Long-Term Investments

Short- and long-term real estate investments pose different tax concerns, which is why they should be separated into different entities.

  • Short term strategies (such as flipping, wholesaling and rehabbing) should be placed in an entity that helps to reduce self-employment, federal and state taxes.

Long-term strategies (such as owning a rental property) should be placed in an entity that helps to address passive loss rules and minimize taxes through deductions.

Work With a Knowledgeable CPA

To make sure you’re organizing your finances properly for investing, choosing the correct entity structures and taking advantage of the tax breaks you’re entitled to, work with a licensed Certified Public Accountant (CPA) with experience buying, selling and owning real estate properties. Many taxpayers consider it a hassle to file their returns—but if you’re a real estate investor, stop seeing tax season as an inconvenience and start viewing it as an opportunity to maximize your investment profits.

By Chris Cooper, CFP®

About Jacqueline Maddison

Jacqueline Maddison is the Founder and Editor-in-Chief of Rancho Santa Fe Magazine. She believes in shining light on the best of the best in life. She welcomes you into the world of the ultimate luxury lifestyle.

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