When deciding between the various types of financial investments available, you need to evaluate your own financial situation and choose the one that best fits your income profile and the amount of risk you are willing to take. The old adage of having a diverse portfolio of investments, not just stocks, still holds true. What will be important at the end of the year is how much profit you have reaped, so seriously considering real estate has to factor in as a top choice because of the many tax advantages available to you.
There is not enough space in this article to cover every real estate tax advantage so we will choose some of the best ones as a starting point so you can make the best decision for your situation. If after reading the article you are very interested in real estate but don’t yet have the money you can take the information and use it to plan your future investment strategy.
Whether you’re a brand new real estate investor or a seasoned pro, having a tax strategist is an essential first step in maximizing the tax advantages specific to real estate. Laws are changing all the time, and not just tax laws. With your decision to hire a competent and reputable real estate tax strategist the opportunity will be there for you to focus on making money and letting the other guy do their job.
A key word to remember when it comes to taxes is “maximize.” We are not talking about maximizing taxes, but the deductions and income that come with being a real estate investor. For example, you can get a K-1 status by becoming a direct investor in real estate which will allow you to max out both. Maximizing your deductions is critical, and one approach is to accelerate your depreciation by using what are known as cost-segregation strategies. Not all real estate needs to be treated as a single property, but depending on the type of property you are invested in you can move parts of your investment to different asset classes. This is a very sound strategy that can literally save you thousands of dollars every year.
An approach we like to call the “non-profit” approach is to choose income reinvestment over distribution. For example, 501(c) businesses are to reinvest their profits back into the business, either through improvements or distributions to employees. While you are not a 501(c) business, you can use the same idea and reinvest your proceeds in other properties. This will minimize your taxes while creating new opportunities for wealth-building. Be aware however that this strategy may not be for everyone, so be sure to consult with that tax strategist we mentioned earlier.
One of the most unique aspects of investing in real estate is you can become a qualified real estate professional or QREP. Beyond just having a formal title, you can use this to your tax advantage by being able to maximize (there’s that word again) your passive losses instead of having to carry them forward to the next tax year. You would almost always choose to report a $1000 loss in the current tax year rather than deduct $500 this year and $500 the next.
Finally, for those who are approaching retirement and are doing estate planning, you can use real estate to reset your basis upon your death. We don’t like to use the “d word” but when it comes to financial planning in the event of your death it is an essential part of life. Resetting your basis simply means you will pass your real estate properties directly to your heirs after you die. The properties do not have to be liquidated or sold, therefore opening the possibility that they will be able to legally avoid paying any capital gains tax.
From the first tax advantage to the last, you can see that many of the advantages in investing in real estate take advantage of the constantly changing financial laws. There are a lot of advantages in that one sentence, but it highlights why you should seriously consider real estate as part of your investment portfolio. Also note the need for a professional tax advisor to keep you apprised of potential changes to laws that will directly impact your end of year profit and taxes.