6 Ways To Pay Less in Taxes on Your Real Estate Investments
Written by
Jordan Rosenfeld
Edited by
Molly Sullivan
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Real estate investing can be a powerful wealth-building tool — but if you’re not strategic, taxes can take a big bite out of your profits.
Whether you own rental properties, flip houses or invest in real estate investment trusts, there are legal strategies to minimize your tax burden and keep more money in your pocket.
Experts gave advice how you can maximize your real estate returns.
Document Everything
The first step to being able to reduce your tax burden from real estate investments is having the paperwork to back up your deductions.
“When it comes to property management and taxes, it is extremely important to make sure you have records of absolutely everything,” according to Adam Hamilton, CEO, REI Hub.
This includes anything from rent receipts to insurance payments to maintenance costs and more.
Take a Mortgage Interest Deduction
Additionally, you should be able to take advantage of the home mortgage interest deduction, Hamilton said.
“With this, property owners can subtract the amount of money they spent on mortgage interest from their taxable income, up to a certain amount, which can then lower the amount of taxes that they owe,” he said.
According to the IRS, you can deduct home mortgage interest on the first $750,000 ($375,000 if married filing separately) of your interest paid. The mortgage must qualify as “a secured debt on a qualified home in which you have an ownership interest.” However, you may qualify for a higher limitation up to $1 million ($500,000 if married filing separately) if you are deducting mortgage interest from indebtedness incurred before Dec. 16, 2017.
Use the 1031 Strategy
Another great way to reduce taxes on real estate income is to use the “1031 strategy,” according to Glenn Barlow, CEO at Stallion Equity.
“As long as you reinvest the profits into a ‘like-kind’ investment, you can defer 100% of the taxes on what you just made. It’s a winning strategy for keeping kicking the tax can down the road — and totally legal to do so,” he explained.
For people who then wonder how they get any benefits in the form of “actual cash to spend,” Barlow said the answers is to borrow money. “Refinance the new transaction and any surplus cash that you realize is 100% tax free because it’s debt.”
Take Real Estate Depreciation
You also want to be sure to use real estate depreciation in your tax calculation when filing your taxes at the end of each year, Barlow said. “It can be huge and oftentimes can get you down to a zero-tax base.”
Set Up an S Corp
If you’re doing a significant amount of real estate investing, consider setting up an S Corp business, according to Brett Johnson, owner of New Era Home Buyers and a Colorado-based real estate investor and real estate agent.
“An LLC is already taxed as a pass-through entity, but electing S corp taxation allows me to minimize my self-employment tax. Instead of taxing all net income with self-employment taxes, I pay myself a reasonable salary subject to payroll taxes and the surplus profit is distributed as dividends without additional self-employment taxes.”
A secondary advantage to this structure is the ability to create a self-directed 401(k), he said. “Using this, I am able to contribute as a worker and a business owner, significantly reducing taxable income while creating long-term capital. This strategy has allowed me to reinvest more into real estate while lowering my tax burden.”
Deduct Everything You Can
Steve Schwab, CEO of Casago vacation rentals and property management, said his number one tip “would be to not let a single potentially deductible expense go forgotten. When it comes to property ownership and management, deductions are everything.”
He said people often fall short of deducting everything they can, either because they don’t realize certain expenses are deductible or because they don’t keep their costs well organized throughout the year, so payments fall through the cracks.
“It can be a good idea to have one centralized location where you store every single potentially deductible expense record throughout the year, even if you aren’t 100% sure if you can claim it,” he said. Create the habit of immediately storing the receipt so that when tax season rolls around, you don’t have to spend time combing through all the money you spent the past year.
It can also be a good idea to connect with an accountant or financial planner who can advise you on what an acceptable deduction is or isn’t.
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