Does Investing in Real Estate Come with Any Tax Benefits?
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Tax Benefits & Real Estate Investing
Real estate investing is widely regarded as an effective tool for long-term wealth building. This is due to its potential for both capital appreciation and steady income generation.
Real estate properties, whether residential or commercial, tend to appreciate over time, providing investors with significant capital gains when they sell. Rental properties also offer a consistent stream of income that can help cover mortgage payments, maintenance costs, and other expenses, often resulting in positive cash flow.
Investors can even benefit from leveraging, where they use borrowed capital to increase the potential return on investment (ROI). Done right, real estate investing can be lucrative. At the same time, it diversifies your existing investment portfolio. [1]
However one of the biggest reasons investors add real estate to their investment portfolio is because of its significant tax benefits. Here we will discuss some of these tax benefits so that investors know how to make the most out of their investment properties.
Does Investing in Real Estate Come with Any Tax Benefits?
Beyond the potential for appreciation and rental income, one of the key attractions of real estate investing is the array of tax benefits it offers. Most of these tax benefits exist because the government wants to incentivize people for investing in real estate.
Understanding these benefits can help investors maximize their returns and make informed financial decisions. Here are some of the tax advantages that come with real estate investment:
Mortgage Interest Deduction
Mortgage interest deduction is a significant tax benefit for real estate investors, allowing them to deduct the interest paid on loans used to acquire, construct, or improve a property. This deduction applies to both residential and commercial properties. This provides substantial savings, particularly in the early years of a mortgage when interest payments are higher. [2]
By reducing taxable income, the mortgage interest deduction can lead to lower overall tax liability. This benefit encourages property ownership and investment, aiding investors in building equity and enhancing cash flow, ultimately contributing to long-term wealth accumulation.
Property Taxes
Another significant advantage is the ability to deduct property taxes from your federal income tax. This deduction applies to the annual property taxes paid on the real estate property, which can substantially reduce the investor’s overall taxable income.
Additionally, investors can often write off other related expenses, such as property management fees, maintenance costs, and depreciation. These deductions collectively lower the tax burden, making real estate a more attractive investment option for tax-conscious investors.
Operating Expenses
Investors can deduct many expenses related to the operation and maintenance of their rental properties, effectively reducing their taxable income. Aside from property management fees and maintenance costs, this could also include repairs, insurance premiums, utilities, and even advertising for tenants.
By carefully tracking and claiming these deductions, real estate investors can significantly enhance their after-tax return on investment.
Depreciation
Depreciation is one of the most significant tax benefits of real estate investing. It allows investors to deduct a portion of the property’s value from their taxable income each year.
The IRS permits the depreciation of residential rental properties over 27.5 years and commercial properties over 39 years. It reflects the assumed wear and tear that buildings naturally undergo as time passes. It is worth noting that this deduction can significantly reduce an investor’s taxable income, even if the property’s value is actually appreciating. [2]
For example, if the value of a building is $300,000 (excluding the land it sits on), you can deduct $10,909 in depreciation each year by dividing that value by the 27.5 year expected life of the property. [2]
Depreciation is a non-cash expense, meaning it does not involve an actual outlay of money. This can lead to a scenario where an investor has positive cash flow from the property but reports a lower taxable income or even a tax loss.
When you sell, you will have to pay the standard income tax rate on the depreciation you have claimed. This is called depreciation recapture. However, investors can defer paying taxes on the depreciation recapture by utilizing a 1031 exchange when the property is sold. [2]
1031 Exchange
The 1031 exchange is named after Section 1031 of the Internal Revenue Code. It is a powerful tax-deferral strategy for real estate investors that allows them to defer capital gains taxes on the sale of an investment property by reinvesting the proceeds into a similar or “like-kind” property.
As long as the new property you purchase is equal or greater value than the one you sell, you can use the 1031 exchange to swap them for tax purposes. You can therefore defer paying the capital gains tax on the sale of the first property. [2]
This exchange must adhere to specific IRS rules like identifying potential replacement properties within 45 days and completing the purchase within 180 days.
By deferring capital gains taxes, investors can leverage more capital for reinvestment, potentially enhancing their portfolio’s growth and cash flow. This strategy also helps with the diversification of properties, improving investment positions without immediate tax burdens.
While these exchanges can be used indefinitely, investors will still have to pay the tax they owe once they cash out their profits. [2]
Pass-Through Deductions
A pass-through deduction allows investors to deduct up to 20% of their qualified business income (QBI) from their taxable income. This deduction is available through the Tax Cuts and Jobs Act (TCJA). [2]
Qualifying real estate investments typically include rental properties and real estate investment trusts (REITs). The pass-through deduction can result in substantial tax savings for investors, effectively reducing the amount of income subject to federal taxes. It provides a good incentive for individuals to invest in real estate to generate passive income while minimizing tax liabilities.
Take note that this perk is currently set to expire in 2025, along with other provisions included in the Tax Cut and Jobs Act of 2017. [2]
Capital Gains Exclusion
For primary residences, there is another notable tax benefit in the form of capital gains exclusion.
Under the Internal Revenue Code Section 121, homeowners can exclude up to $250,000 of capital gains if they are single, or up to $500,000 if they are married and filing jointly, from the sale of their primary residence. [2]
To qualify for this exclusion, the homeowner must have owned and lived in the home as their primary residence for at least two out of the five years preceding the sale. This exclusion can be used repeatedly as long as the conditions are met, allowing homeowners to potentially avoid significant capital gains taxes over their lifetime.
The Best Real Estate Investment for Accredited Investors: Multifamily Syndication
Real estate investing offers numerous tax benefits that can enhance the profitability of your investments. From mortgage interest deductions and depreciation to the strategic use of 1031 exchanges, these tax advantages give investors even more reason to add real estate to their investment portfolio. Leveraging these tax benefits can help bring investors closer to their financial goals.
As with any investment strategy, it is important to consult with a tax professional to fully understand how these benefits apply to your specific situation. This is also necessary to ensure that you are in compliance with all applicable tax laws.
If you are an accredited investor and you want to add real estate to your portfolio, there are a lot of options to consider. However, it may be a good idea to take advantage of certain investment opportunities that are exclusive to accredited investors, such as multifamily syndication.
Multifamily syndication is a passive investment in real estate that is typically exclusive to accredited investors. It is an investment strategy that involves multiple investors pooling their funds together to acquire a single real estate property. [3]
Real estate syndication deals are arranged by a syndicator, also known as a sponsor, who is in charge of creating and executing the business plan from start to finish. They take on the role of general partner (GP) in the deal. This means they have the most responsibilities and face most of the liabilities. [3]
The syndicator is in charge of locating the investment property, performing due diligence, securing the loan, and finding investors who will participate in the syndication deal. Meanwhile, investors only have to provide a portion of the capital needed to purchase the real estate property. They are limited partners (LPs) in the syndication deal.
Investors also pay certain fees in order to get the syndication deal going. However, they have no further responsibilities beyond that. They earn a percentage of the property’s cash flow in exchange for their investment. This may be distributed on a monthly or quarterly basis. Investors may also get a share of the equity upon resale—but this depends on the deal structure. [3]
Keep in mind that every syndication deal is different. LPs still need to perform their due diligence and understand everything involving the syndication before joining it. Accredited investors should study the private placement memorandum (PPM) or the syndication agreement before participating in a syndication deal. The profit split will also be detailed in these documents.
Real estate syndication deals can be done with almost any type of real estate. However, multifamily syndication is the most popular because of the strong and predictable cash flow associated with these larger properties. [3]
Apartment communities and condominiums also tend to be more expensive and more difficult to manage for a lone investor. Therefore, participating in a multifamily syndication deal is a lot safer. This type of investment makes real estate investing more accessible for investors. [3]
In fact, the syndicator will also be responsible for property management, meaning investors do not have to worry about becoming a landlord. They can avoid the headaches that come with owning real estate, while still benefiting from it.
While multifamily syndication solves a lot of the problems people have when it comes to real estate investing, most of these deals are exclusive to accredited investors. The US Securities and Exchange Commission (SEC) allows accredited investors to invest in unregistered securities and real estate syndication deals that are normally inaccessible to regular investors. [3]
This is because accredited investors have the investing knowledge and experience to assess these investments properly. They even have the net worth and income to act as a safety net in case an investment does not work out.
This level of knowledge and investing experience is important because even multifamily syndication has its risks. For example, these deals tend to last for several years, meaning investors must be comfortable with a bit of illiquidity. It is also not an ideal fit for investors who do not like taking the backseat when it comes to their investments. In a syndication deal, the syndicator will be the one to make all the decisions involving the property.
With that said, real estate syndication allows accredited investors to just sit back, relax, and enjoy the benefits of owning real estate without the challenges that are usually associated with it.
Work With BAM Capital for the Best Multifamily Real Estate Syndication Deals
Accredited investors know the importance of choosing a trustworthy syndicator when participating in real estate syndication deals.
If you want to work with a syndicator with a track record for reliability and excellence, choose BAM Capital.
This Indianapolis-based syndicator prioritizes high quality multifamily real estate properties that have in-place cash flow and proven upside potential. BAM Capital focuses on properties that are Class A, A-, and B++. They then use their award-winning investment strategy to create forced appreciation while mitigating investor risk. [4]
This approach has allowed BAM Capital to build up a reputation as a leader in its industry. In fact, BAM Capital now has over $700 million AUM and 5,000+ units. [4]
BAM Capital is also a vertically-integrated company. This means they can guide you through every step of the syndication process. They can handle everything from acquiring the properties to renovating and managing them.
No investment is without risk. Make sure to consult your investment advisor or speak to a BAM Capital investment team member before making any financial decisions.
For accredited investors who want to enjoy the passive income and all the other benefits of being in a multifamily syndication, schedule a call with BAM Capital and invest today.
Sources:
[1]: https://www.nerdwallet.com/article/investing/5-ways-to-invest-in-real-estate
[2]: https://www.rocketmortgage.com/learn/tax-benefits-of-real-estate-investing
[3]: https://multifamilyrefinance.com/apartment-investing-blog/multifamily-syndication#important
