How long have you been investing in real estate? Even if you are just getting started, you may soon be eligible for professional status. In that case, there are tax incentives especially for you.
By the IRS’s criteria, a real estate professional does not have to obtain a license. There are two qualifiers for real estate professionals as noted by the tax code:
- If more than half of the personal services performed by the taxpayer during the tax year are in real property trades or businesses in which the taxpayer materially participates.
- More than 750 hours are spent during the tax year providing personal services in real property trades or businesses in which the taxpayer materially participates.
This means that over half of the work you are engaged in is in real estate; it must be more than the combined hours of all other work that you do. And this work must add up to at least 750 hours across the course of the year. So if you’re already putting in 40 hours/week as an employee in another industry, you’re going to have to knock yourself out to take advantage of the loopholes designated for those working in real estate. Do the math: you’re already working 2,000 hours/year. You have to double it, and then some, in order to qualify. But if the real estate dabbling you’ve done has stretched to become the mainstay of your professional time: congratulations! You’re the real deal – a true real estate professional.
Now that you’re “in”, get caught up on the ways to work the tax code to your advantage. This is where it gets good.
Keep It In The Family
This is more of a loophole to the above qualifiers. If you are married and your spouse is a real estate professional, losses claimed from that person’s real estate business may be used to offset overall income. This includes income generated from another industry. Please note that only one income needs to qualify, and that overall real estate work hours may not be combined from two individuals.
Depreciation
Considered a capital expense, depreciation is the method of accounting that spreads an asset’s cost across multiple years. It therefore protects other income from being taxed, reducing your tax bill. It must be taken over the expected life of the property. If you’re renting out a property, the IRS says it can begin to depreciate once it is ready and available for rent. Depreciation is considered a paper loss, which means you don’t have to spend any money in order to deduct it as an expense.
Avoid Capital Gains Tax
After purchasing your flip, move right in to take advantage of one of the government’s more generous tax exemptions. If you can manage to maintain the home as your principle residence for two of the following five years, you can make a quarter million in tax-free profit as an individual, a half million as a couple.
Earn Off Your Rental Income To Avoid Payroll Taxes
If you’ve got rental properties, the income they deliver will not be subject to social security or Medicare taxes. These FICA taxes are costing you 7.65% off of your earned salary. Cut out the paycheck, and you lose the cut. It’s not a major shave, but adds up over time.
Refinance
You can sell your investment to raise capital, or you can refinance under the right terms. In the latter case, you save big on taxes. The cash you get from the refinance is borrowed, so not taxed. Just be sure to go low on the rate, and long on amortization, and get a rate that’s fixed.
Take Advantage of Capital Gains Tax Rates
The rates for the long-term capital gains tax can change, but tend to remain lower than income tax rates. If you sell real estate strategically as part of a long-term plan, you can take advantage of these rates when they are at their lowest. The best part about taking advantage of the loopholes written into our tax code is that the money you save can be used to further your real estate growth. It’s a win-win situation, and worth weaving into your long-term real estate investment strategy.