Audrey
Purchasing property is certainly an exciting endeavor, regardless of the circumstances. But with big investments come big responsibilities, including taxes. Thankfully, whether you’re signing the rights as an individual or a business owner, there are numerous ways to lighten the tax burden that comes with buying property.
Real estate tax breaks are great ways to help you save money, both in the short and long term. As a real estate investor, you can deduct money from your mortgage interest, get credits for various home improvements, or claim back if you work from home.
Below, we explore the ins and outs of real estate tax breaks, the benefits of real estate investments and tax deductions, and how to reduce your tax liability to help you with your investment properties.
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What is a real estate tax break?
In essence, a tax break is a tax deduction or tax credit the government provides that reduces your total tax liability. This, in turn, can save you money on your overall tax bill. When talking about a real estate tax break, the tax refers to deductions for the real estate sector.
If you’re a rental property owner, real estate investor, or commercial real estate proprietor, you can deduct specific costs that relate to owning, maintaining, and fixing your property.
The difference between tax credits and a tax deduction
A tax credit serves as a direct reduction in the amount of taxes owed on a property by the investor or owner, which increases the profitability of the investment.
Say you owe $5,000 in tax, but you are eligible for real estate tax credits of $2,000, your final tax liability would amount to $3,000.
On the other hand, a tax dedication allows for a reduction in taxable income by subtracting certain expenses related to the property ownership, such as mortgage interest, property taxes, and other qualifying expenses, from their gross income.
For example, if your tax bracket is 25% and you qualify for a $1,000 tax deduction, $250 dollars will be subtracted from your tax.
How do tax breaks work?
Tax breaks for the real estate sector are designed to incentivize investment in real estate and promote homeownership.
Real estate investors also benefit from tax breaks, such as the ability to deduct expenses related to the rental of their properties, including mortgage interest, property taxes, and maintenance costs.
These tax breaks can greatly reduce the cost of homeownership and investing in real estate, making it more accessible to a broader range of people and stimulating economic growth in the housing sector.
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The different types of Real Estate Tax Breaks
There are many benefits of real estate investing. We explore the main tax returns and tax deduction situations below.
Mortgage Interest Deduction
One of the most common tax breaks is the mortgage interest deduction. This type of tax break allows homeowners to deduct the interest paid on their mortgage from their taxable income. This deduction can be significant, especially in the early years of a mortgage when interest payments are highest. This is something a lot of first-time homebuyers miss out on, so if you or someone you know falls into that category, it’s worth reading up on preparing to buy your first home.
Property Tax Deduction
Homeowners can deduct property taxes paid on their primary residence and any second homes they own. You can deduct up to $10,000 in state and local property taxes on your federal income taxes based on your paycheck stub each year. This includes real estate taxes on your primary residence as well as any additional properties that you own.
Capital Gains
When you sell an investment property, whether it’s rental, commercial, private, or industrial, you make a profit. These profits are taxed either short or long-term, which is called a capital gains tax. Short-term refers to a property you’ve had for less than a year, whereas long-term refers to property you’ve held for a year or more.
A capital gains exclusion is when homeowners can be exempt from paying taxes on profits of up to $500,000.
Rental and Property Depreciation Deduction
A valuable tax break for investors, depreciation allows you to deduct a portion of your property cost each year over its useful life. This means that, over time, your property is something that will either decay, wear out, or lose value.
So, instead of taking a large deduction when you either purchase or improve the property, you can take smaller amounts off over the property’s life span.
Repair and Improvement
When you repair your property, you can take the total cost as a deduction on the year you pay for the improvement. This includes fixing the plumbing or replacing a broken window. Once you’ve paid for that repair, you can reduce that amount from your tax.
However, this is not the same when you improve something on your property. For example, if you install a new roof or extend the patio, you are improving the value of the property. This cannot be deducted from your tax liability. It can, instead, spread out the cost over the property’s useful life.
Energy Efficiency
Homeowners who make energy-efficient improvements to their homes may be eligible for energy efficiency credits on their taxes. For example, installing solar panels or energy-efficient windows can qualify for tax credits.
Home Office Tax Deductible
If you use part of your home exclusively for business purposes, you may be able to claim a home office deduction on your taxes. To qualify for this deduction, the space must be regularly and exclusively used for business activities such as meetings or administrative tasks.
Opportunity Zones
Opportunity zones are categorized as some of the country’s most underdeveloped and rural areas. If you, as a property investor, place your capital gains into an opportunity zone fund, you will not have to pay any capital gains on the profits you made from your original investment.
1031 Exchange
When you exchange one real estate asset or investment property for another, you will not receive any tax at the time of the exchange. If you are an investor, you can, therefore, keep the profits from one investment and avoid paying taxes until you decide to sell your property.
How to save money with real estate tax strategies
To make the most out of real estate tax breaks, organization is key. Throughout the tax year, be sure to:
- Keep all receipts to make sure you’ve got everything covered when it comes to expenses and tax filing.
- Organize expenses into categories to keep track of the specific costs linked to the property.
- Identify and keep tabs on all possible business expenses you can deduct to get the most out of tax benefits.
- Prepare and keep accurate financial statements to grasp how well the investment is doing and to make smart decisions.
- Sort and analyze the types of investments made on the property to identify areas of strength and opportunities for improvement.
Reap the rewards as a real estate investor
When it comes to real estate investment tax, these tax benefits can help lower your taxable income. Whether you run a real estate business, receive rental income, or simply want to make certain deductions available on your private property, you can make use of the tax breaks mentioned above.
To help you maximize your tax breaks and make the most tax savings, you can ask the help of a tax professional. From deducting mortgage interest to standard deduction strategies, there are many ways you can lower your tax rate within the real estate sector.
