Real Estate Investing as a Tax Strategy

Real estate investing might be worth considering if you’re looking for a passive way to improve your portfolio. In addition to earning high returns, real estate assets can qualify for significant tax deductions. These deductions can help offset tax liabilities on other investments. Find out if real estate investing as a tax strategy is right for you.

What Is Real Estate Investing?

Real estate investing is the process of buying or selling real estate assets with the intention of producing a profit. Owning real estate has become a popular investment strategy because it offers investors the ability to earn passive returns at a much faster speed than other options.

Key Takeaways

• Real estate investing as a tax strategy might be a way to reduce your tax liabilities and offset other investment losses.
• Real estate offers exceptional investment growth opportunities through appreciation and tax benefits.
• Real estate assets often qualify for ample deductions, including property taxes, repairs, maintenance, and depreciation.
• Investors have multiple investment options in real estate, including flipping, rental properties, vacation rentals, and rent-to-own properties.

Overview of Tax Strategies

Real estate investors might earn a profit by timing the market when buying or selling. Some investors might also purchase a property, make necessary repairs, and then sell it for a higher price. Other real estate investors might purchase a property, fix it up, and turn it into a long-term or vacation rental.

Benefits of Real Estate Investing as a Tax Strategy

Investing in real estate as a tax strategy offers many benefits, including:

Investment Growth

One of the biggest benefits of investing in real estate is the investment growth potential. Real estate assets have the potential to return significant profits on your initial investment, especially if they’re given time to appreciate. Whether you decide to flip, rent to a long-term tenant, or create a vacation rental, you’ll also build equity in your asset. The longer you hold on to an asset, the more equity you’ll build.

Most home values also appreciate or increase over time. Holding a property for a few years in the right market can lead to the property being worth significantly more than when you originally purchased it.

Tax Deductions

Buying, selling, or managing real estate assets comes with many costs, but the good thing is you can write off many of these costs on your yearly taxes. Real estate assets offer investors a long list of deductions, including mortgage interest, property taxes, maintenance and repairs, and depreciation. A write-off decreases your taxable income, which could reduce how much you owe in taxes.

Certain real estate tax deduction strategies can also provide you with access to more deductions. A few of these include structuring assets in a self-directed IRA, holding properties for a minimum of two years, taking advantage of pass-through deductions, and deferring taxes with a 1031 exchange.

Diversification

The many investment strategies available in real estate investing make it possible to diversify your portfolio. Diversification is a common strategy investors can use to limit losses in other investment categories. Investing in multiple markets and property types allows you to take advantage of different tax benefits while also offsetting the risk of declining markets.

Investment Strategies

You have a few options available when it comes to investing in real estate, including:

Flipping

Flipping refers to buying a house that needs repairs, making those improvements, and then selling it as move-in ready for a higher price. Investors who engage in real estate flipping tend to hold on to the property for a short time. Flipping can be a great way to profit quickly, depending on the necessary repairs and the investor’s ability to manage them.

Fixing and Renting

Some investors prefer a longer-term approach to investing in real estate. Buying a fixer-upper and then renting it to a single family on a long-term basis provides you with passive monthly income. You might even consider investing in multifamily properties, allowing you to earn even more monthly.

This option also allows you to build equity, which is the difference you owe on your mortgage compared to the home’s value. Long-term real estate assets also tend to qualify for more deductions because you’re responsible for keeping up with maintenance, taxes, and other costs while holding the property. Rental properties also depreciate over time, meaning you have access to even more deductions.

Vacation Rental Property

A vacation rental property is similar to a rental, except it’s usually located in a tourist area. Instead of renting to a single family for a long period, many renters will book the property throughout the year while on vacation. Vacation property owners might have higher operating costs but can usually charge more per visit.

Lease-to-Own Property

A lease-to-own property is a good balance between flipping and renting. Flipping and then selling a property within a short period usually comes with high tax implications. Tax liabilities on long-term rentals tend to be less, but they might require the investor to be more active in the daily operations of the investment.

Flipping and then selling on a lease contract is a good balance that splits your profits over a longer period, helping you control taxes.

Risks of Real Estate Investing

As with any investment, real estate also has its risks. Some of the most common risks of real estate investing include:

Market Fluctuations

The housing market is subject to increases and decreases. Home values depend on supply and demand and the recent sales price of nearby, similar properties. A sharp decline in the housing market could cut into returns.

While it’s not always possible to time the market to avoid costly fluctuations, negotiating a good price can help offset the risk. Additionally, any real estate losses incurred from fluctuating markets can be write-offs.

Tenant Issues

Long-term real estate investors rely on tenants to make their payments on time each month and to take proper care of the property. Tenant issues can lead to expensive repair costs. Tenants who refuse payment can cause investors to accumulate costly legal fees. Planning ahead for these potential costs or working with a property management company that covers tenant issues can reduce this risk.

Unforeseen Expenses

Unforeseen expenses can arise at any time with real estate. Some housing repairs are expensive, such as a new roof or appliances. While these costs might be expensive upfront, they can reduce taxable income and increase the value of the home.

Real estate assets are also subject to variable costs, such as property taxes and insurance. These rates can increase year over year, making it important to price shop frequently to control costs. Ensuring you have sufficient insurance on your property can also protect against certain costs.

Taxes

The IRS requires payment in the form of taxes on all earned income, including real estate investments. Buying and selling for a large profit can lead to expensive capital gains taxes. However, there are ways to reduce your tax liabilities on capital gains.

The highest tax rate occurs on short-term capital gains, which are assets you buy and sell within a year. This is most common with strategies that involve flipping properties. Long-term capital gains receive lower tax rates, making it potentially worthwhile to hold on to your property for a little longer.

Other options, such as differing taxes, can also help you control tax requirements of short-term real estate assets. Another common way around short-term capital gains taxes is to live on the property while making repairs. Living on the property for at least two years might qualify you for capital gains exemptions.

Why You Should Use Real Estate Investing as a Tax Strategy

Real estate investing can be a great way to reduce your tax bill. Whether you’re using your real estate assets to earn passive income, write off deductions, or claim losses, real estate investing offers many benefits. Want to learn how real estate investing can fit into your tax strategy? Call our team at Anderson Advisors today for a customized strategy.