5 Tax Tips for Real Estate Investors
# 1. Start thinking about the coming year now. Get a good CPA
It’s never too soon (or late) to consider all the Realtor tax deductions possible! First step, find a competent local Certified Public Accountant (CPA) who is also a real estate investor who owns rental property, as well as buys and sells real estate for investment purposes. Be patient and persistent and avoid getting discouraged. They exist.
# 2. Hold Short Term & Long Term Investments in Different Entities
Once you have located your real estate investor friendly CPA, the first thing you should do is separate your short term investing activities (less than 1 year) from your long term investments (more than 1 year). Wholesaling, flipping, and rehabbing are typically short-term investing activities whereas owning rental property is usually considered long-term investment activity.
The type of entity for each may be different, and your CPA will be helpful in this decision. Let your CPA help you figure out which entity structures are right for you.
# 3. Get Organized
If you’re first response to this tip is that you are not an organized person, I’ve got something important to share with you. The IRS will punish you severely if you refuse to be organized in your business endeavors. The list of no-longer-rich people who have learned this lesson the hard way is long and distinguished.
Look at it this way, you need many skills to be a successful real estate investor, from finding the best deals and structuring transactions so that all parties benefit to executing exit strategies for maximum profit–just to name a few. In addition to those fun and exciting skills, you need to be organized in your accounting and bookkeeping. It’s just part and parcel of being an investor, entrepreneur, and small business owner.
Every expense and every item of income in your real estate business must be organized into a system that is easily accessible. Most small business owners use Quick-books because it is the standard digital format for the accounting world. When your business books are correctly organized in Quick-books, you have incredible control over your operation’s accounting.
# 4. Own Rental Property
Rental property is one of the greatest ways to earn money in the United States. Income from rental property is incredibly tax advantaged. When you buy a $100,000 rental home, you get to depreciate the structure of the property (not the land) over 27.5 years. Let’s say the lot is worth $10,000, that means the structure (and your tax basis) is $90,000. Each year, you get a tax deduction of $3,272.73 ($90,000 divided by 27.5 years).
So after all expenses, including maintenance, if your cash flow on that rental home is $270 per month, depreciation offsets that cash flow completely and you may not have to pay any taxes on that income! It’s incredible. Plus, as the property increases in value, you’re not paying any tax on the appreciation so long as you continue to own it.
# 5. Earn Income Like the Wealthy
You’ve probably heard politicians talk about how the wealthy pay so little in taxes. Technically, the wealthiest people in this country pay a very large total sum in taxes but, on a percentage basis, it is far less than the middle class. Why?
Because the wealthy earn some (or all) of their income through investments as opposed to working for other people. Rental property is one such investment that allows the wealthy to earn great money but not incur a heavy tax liability. Another example is when you sell your rental property after more than one year of ownership. That may incur a long-term capital gains tax (15%…soon to be 20%) as opposed to ordinary income tax (15% – 35%+).
An example of how this can work is if you buy a property, fix it up, and sell it on a 13 month rent-to-own, so that the tenant buys the property in little over one year. The net profit can then potentially be considered a long-term capital gain. Not only is your tax liability potentially much less, but you also can usually sell a property on a rent-to-own for top dollar and you typically have no real estate commissions. That’s a winning combination!
Another creative way to reduce your tax liability by earning income like the wealthy is with a 1031 exchange. When you sell that rental property, your profits may not be taxed at all if you do a 1031 exchange and move all that money into a new property purchase. In simple terms, this is the real world example of what you do in the game of Monopoly when you exchange 4 green houses for 1 red hotel.
How can the wealthiest people in this country pay the least percentage-wise in taxes? They earn their income from investments as opposed to jobs. Shouldn’t you be earning more of your income from investments too?