Perhaps one of the greatest advantages to real estate investing is the multitude of tax deductions that can be utilized. Consequently, these same tax deductions add a great deal of complexity to real estate investing. 1040s, Schedule Cs, Publications, where do you even begin?
When you purchase an investment property, you’ve just started a business. As with any other business, your operating expenses are tax deductible. You can deduct a great deal of expenses when you own rental property. Here is a good general list of tax deductible items:
A key tax benefit you get with real estate is the ability to take depreciation deductions on the cash flow you receive for the property throughout your ownership period. With enough properties, you can live off that passive income, tax free. Often, your depreciation loss is higher than the cash flow you are receiving. How does that loss benefit you? Keep reading below to learn about the “Real Estate Professional Status.”
We also cover depreciation in further detail in another blog post, as it’s one of the 5 “IDEAL” Reasons you Need to Invest in Real Estate.
Although most people are aware that mortgage interest for your primary home can be tax deductible, most people do not consider the mortgage interest deduction that you can also enjoy with a rental property. This is more money in your pocket, considering the tenant is paying the interest for you anyway!
- Property Tax
- Homeowners Insurance
- Capital expenditures (upgrades to property)
- Advertising/marketing/website expenses
- Professional fees (CPA, attorney, bookkeeper)
- Travel related to your business or properties
- Home office expenses for your business
- Cleaning and maintenance expenses
- Property management expenses
- Home inspection expenses
- Painting, carpet replacement and other repairs done between tenants
- Utilities paid between tenants
What’s Your Real Estate Professional Status?
If you are a “real estate professional”, you get to take advantage of an unlimited amount of real estate deductions each year on your tax return. There are two hard and fast rules for you to qualify, per the IRS:
1) Spend more than half of your time in “real estate activities”
2) Spend more than 750 hours in real property businesses and rentals.
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If you do not pass BOTH of these tests, although you are a real estate professional per se, these losses are passive losses, which is a whole different ballgame. In this case, you generally cannot claim losses greater than $25,000. Please be sure to meet with a CPA or reliable tax advisor (it’s one of your deductions!) to make sure you aren’t filling Uncle Sam’s coffers too high come tax time. The tax advisor will help you validate your real estate professional status if you are eligible. If you do, in fact, qualify as a real estate professional, you need to make sure this election is included with your original tax return upon filing.
Real estate means control, and control of taxes is one more way you can benefit from owning physical real estate. This knowledge will allow you to bravely settle up with Uncle Sam in April who is always ready for a rematch. There is only 5 months until tax time, but try to curb your enthusiasm. Sit back with a smug demeanor, watch the snowflakes fall with disregard, and confidently count your money as your investments cash flow. You can rest assured that tax time will be ever so sweeter while a host of tax deductions rally towards your beck and call, keeping more Benjamins at your side.