Tax Advantages of Real Estate Investments

Note: this is Chapter 3 of an entire guide on Why Real Estate Investing?

Ever wondered why multi-million or multi-billion dollar business owners and companies are able to effectively pay 0 taxes? It's not a mystery — it's tax incentives by the government!

As with any investment, real estate owners are subject to pay taxes, which usually falls into two categories. You'll pay income taxes on rental income and capital gains taxes on any appreciation. But don't worry, there's a number of tax incentives to help ease your operation along.

As a real estate owner, these are the most common tax incentives that you'll be able to take advantage of. Basically, this is how to maximize gain potential with free money (thanks Uncle Sam!).

This chapter will break down each in detail, but here's the list:

1. Deductions (this one is huge)
2. Depreciation
3. 1031 Exchange

Deductions

Deductions are the primary advantage to owning a rental property. This basically allows you to decrease your rental income on paper by calculating the expenses you may incur while owning your rental income.

Owning a rental home is treated similar to owning a business. Below is a breakdown of the most common that you may encounter. Consulting a tax advisor may help reveal more nuanced deductions you may be able to take.

1. Loan Costs and Loan Interest is typically the largest deductible expense. When getting your loan, you typically pay origination fees. Moreover, every month, you pay a portion of your mortgage in principal and in interest. The interest can be deducted as an expense when completing your taxes.
2. Property Taxes are taxes paid to a local and/or state government which can range from hundreds of dollars to thousands depending on home value and locale. In your escrow document, you can find the amount owed. Even more nuanced, some local areas may have occupancy taxes which are typically for short-term rental properties. But these taxes are completely deducted.
3. Insurance Premiums refers to any insurance policies pulled out on a rental home. During the home-buying process, you may opt to purchase homeowners insurance, liability insurance, and more. These can be deducted as expenses. Moreover, once you begin to grow your real estate empire, you may hire employees whose insurance premiums are also deductible.
4. Maintenance and Repairs can also be deducted provided they are intended to keep your home in "rentable condition." Note that home improvements are typically considered under depreciation (discussed below) rather than as maintenance and repairs. You may also deduct labor costs if you hire a professional to do these for you.
5. Utilities like gas, electricity, water, heating, and air conditioning can be deductible provided you pay for them per your tenant agreement. If your tenant decides to pay for the utilities, these will add onto your income less the cost of the utility.
6. Legal and Professional Fees may also be deducted if they are purchased for your rental home. For example, you can deduct the cost of a tax advisor to figure all of this out. But you can't deduct the cost of the tax advisor for your personal taxes. If you purchase a home through Doorvest, you may also deduct our property management fee. This is likely to become a large deduction in the beginning year of your rental as you'll likely need to hire a real estate agent, lawyer, tax advisor, or more! Note: you cannot deduct the legal fees that are used to defend your property's title.
7. Travel and Transportation can also be deducted. So if you drive from your residence to your rental, you can deduct the transportation fee via the standard mileage rate which is 56 cents in 2021.
8. Office Space can also be deducted. You don't have to literally rent an office. You can deduct the a spare bedroom in your own home if it is dedicated as an office space. You may also deduct any office expenses (printer, computer, etc).

As with most things, it's important to have proof of these expenses. Maintain clear receipts and records of these costs and purchases in case the IRS decides to flag and audit you.

Depreciation

Depreciation is a type of special deduction that is utilized by huge companies like Apple and Amazon to tax away their investment in property.