Updated: Apr 16
As April 17, 2023, the deadline for individual tax filings approaches, taxpayers nationwide are busy gathering receipts, crunching numbers, and navigating the complex world of tax codes and regulations. If you're a real estate investor or considering investing in real estate, there are plenty of strategies to minimize your tax liability and maximize your savings.
Real estate has long been recognized as a powerful wealth-building tool, and savvy investors know it can offer significant tax benefits. So, whether you're a seasoned real estate investor or dabbling in property ownership, this article will explore some top tips for leveraging real estate to lessen your tax burden and build wealth during tax season. Let's dive in!
Request a 6-Month Extension if Needed
If you cannot file your taxes by the deadline, it's crucial to take action to avoid penalties. Contact your CPA or tax software to request a 6-month extension. An extension will give you additional time to gather documents and ensure accurate tax returns AND deductions. But extending your time to file does not exempt you from needing to make a payment, should you owe. Penalties and interest accrue until payment is received in full.
Consider Setting Aside Tax Refunds for Real Estate Investments
If you're expecting a tax refund, congratulations! Receiving unexpected money can be an excellent opportunity to put that money towards a down payment on real estate. Whether you want to purchase your first home or invest in rental properties, setting aside your tax refund in a separate checking account can help you achieve your real estate goals. Money market accounts offer higher interest rates than savings accounts and are still as liquid. Consider this investment type to earn up to 4.8% (interest rates at the time of this blog post).
Create Partnerships for Tax Benefits
Creating partnerships in real estate investments can provide tax benefits. By partnering with other investors, you can share the tax burden and potentially reduce your overall tax liability. This can be done through various types of partnerships, such as limited partnerships (LPs) or limited liability companies (LLCs).
Become a Real Estate Professional for IRS Designation
To qualify as a real estate professional for IRS designation, you must meet certain criteria, including spending more than 50% of your time and more than 750 hours per year on real estate-related activities. You can offset real estate losses against your other income by meeting these requirements, reducing your overall tax liability.
Consider a 1031 Exchange for Tax-Deferred Real Estate Transactions
A 1031 exchange, also known as a like-kind exchange, allows you to defer capital gains tax on the sale of investment properties if you reinvest the proceeds into a similar property within a certain timeframe. This can be a powerful strategy for preserving investment capital and reducing tax liability.
Cost Segregation for Faster Depreciation
Cost segregation is a tax strategy that allows you to accelerate the depreciation of specific property components, such as fixtures, appliances, and improvements, over a shorter period. This study can result in higher depreciation deductions, offsetting rental income and reducing your overall tax liability.
Historic Tax Credits for Property Improvement
If you own a property located in a historic preservation district, you may be eligible for historic tax credits for property improvement. Historic tax credits can incentivize renovating and preserving historic properties, reducing overall tax liability. In Louisville, the qualifying historic preservation districts are: West Main St, Cherokee Triangle, Old Louisville, Clifton, Parkland, and Butchertown.
Kentucky offers Historic Rehabilitation Tax Credits - financial incentives to encourage private investment in historic properties. Historic Rehabilitation Tax Credits offer a dollar-for-dollar reduction in income taxes owed by the property owner based on the qualifying rehabilitation expenses.
Consult with Your CPA for Tax Planning
If you owe a large tax payment this year, consult your CPA about strategies to offset future gains through real estate investments. For example, creating partnerships, becoming a real estate professional for the IRS designation, conducting a 1031 exchange when selling investment real estate, cost segregation on larger real estate purchases to accelerate depreciation, and historic tax credits for property improvement on houses located in historic preservation districts are some strategies that can be considered.
Below is a list of the top real estate tax savings opportunities.
Mortgage Interest Deduction: Homeowners can deduct the interest paid on their mortgage.
Property Tax Deduction: Property taxes paid on real estate are generally tax-deductible.
Depreciation Deduction: Real estate investors can depreciate their property over 27 years, offering a straight-line deduction for the time you own the property.
Home Office Deduction: If you use a portion of your home exclusively for business purposes, you may be eligible for a home office deduction.
Repairs and Maintenance Deduction: Expenses related to repairs and maintenance on rental properties or other real estate investments can be deducted.
Capital Gains Tax Exemption: If you sell your primary residence, you may be eligible for a capital gains tax exemption on up to $250,000 (or $500,000 for married couples) of the gain.
Energy-Efficient Improvements Deduction: Homeowners who make qualifying energy-efficient home improvements, such as solar panels or energy-efficient windows, may be eligible for a tax deduction.
As you navigate tax season, consider how real estate investments can play a role in reducing your tax liability and building wealth. Real estate offers many opportunities to save on taxes, from deductions for mortgage interest and property taxes to depreciation, home office deductions, and capital gains tax exemptions.
Tax laws and regulations are incredibly complex and subject to change. Please consult a qualified tax professional or CPA to ensure you take advantage of all the applicable deductions and savings opportunities related to real estate investments. Please reach out if you are located in Louisville and need a tax accountant recommendation!