It’s the most wonderful time of the year. (Sense the sarcasm.) You know that period of time where everyone is filing their tax returns. Yes you are right, its tax season! It’s that period of time between January and April and people are preparing the previous year’s financial statements and reports. This is a very busy time of year for many tax preparers and accounting professionals. However, for real estate investors, they benefit quite a lot from tax season. Investing in real estate is one of the ways they cut taxes. Before we get into all the fun about how real estate investors deal with tax season, let us begin with simple facts about tax season.
Tax season opens in January and the deadline is April 15
Taxpayers who file can turn in their returns before January but the returns will not be accepted until the system opens in January. You can either file your tax returns on your own or with the help of a tax professional.
There are lots of late filers
A common behavior that is occurring during tax season is filing late returns. Every year an approximation of about 10 million filers miss the April 15 deadline. Of course one of the most counter-intuitive facts about tax season is the lack of immediate consequences for those not filing or those filing late. The worst thing you can do is not file a tax return because you could end up owing more in penalties and interest than you would have in taxes.
America has the highest tax morale in the world
As much as Americans hate paying taxes, they voluntarily pay more frequently than other nations. The IRS estimated an 84% voluntary tax compliance rate and this rate without a doubt is contributed to the continued overall prosperity of the country.
Many large corporations pay no corporate income tax
There are several examples of large corporations that do not pay corporate income tax. These corporations can avoid paying U.S. corporate income taxes by instead paying foreign corporate income taxes – which can be substantially lower.
While the facts about tax season may go on, what’s important now is real estate investors and how they can deal with tax season. Real estate investing affords certain tax benefits when it involves the direct ownership of a property. For example, investors are able to deduct the value of mortgage interest as well as certain expenses associated with leasing the property, such as maintenance or repairs. So in what ways can investors benefit from tax season?
Property owners have the ability to deduct depreciation value on their taxes. These annual tax deductions help real estate investors to recover the cost of income-producing rental property. The depreciation deduction, along with deductions for other expenses associated with the property, can be used to offset any taxable income it generates. From an investor standpoint, the net result may be a lower tax bill or a deferral of tax liability until the property is sold.
2. Mortgage loan interest
Mortgage loan interest is another deductible expense associated with real estate investments. The amount of loan interest paid on an annual basis is deducted from the amount of rental income received for the year to determine the property owner’s taxable income. When combined with the depreciation deduction, the mortgage loan interest can minimize taxation of cash distributions to investors. This serves to increase the overall return investors gain from the property while decreasing their tax burden. This is very beneficial for real estate investors.
3. 1031 exchanges
According to the IRS section 1031, real estate investors can sell a property, to reinvest the proceeds in a new property and to defer all capital gain taxes. This allows investors to defer taxes by selling one investment property and using the equity to purchase another property or properties of equal or greater value. This exchange is very beneficial for investors. Of course there are procedures that must be followed but it’s a simple process. (Read also 1031 exchange, step by step to understand more about the procedures).
Another beneficial aspect for real estate investors is how they are taxed in terms of capital gains. Real estate crowdfunding is largely a buy-and-hold proposition and with equity investments, the holding period may last from 2 to 10 years. So the long-term capital gains rate would apply for any earnings depending on the sale of the property. The current long-term capital gains rates range from 0 percent to 20 percent, based on your tax bracket. Therefore short-term gains are taxed at your regular income tax rate. That could make a substantial difference in the size of your tax bill if you’re a high income earner.
Tips for real estate investors during tax season
Review your year
For example, review your last year’s tax returns for items that are likely applicable this year. Review your personal tax checklist for new deductions, changes to your business that provide opportunities for new deductions, or see if there are additional points you haven’t thought of before. Always stay organized and you will be on a great track.
Decide to take capital cost allowance or not
Taking capital cost allowance (CCA) in tax terminology, allows you to shelter taxable income from immediate taxes. These are questions you should always ask yourself so you can improve.
Start thinking about the coming year
Start planning with your real estate accountant. Let them answer any questions you have and begin to make a strategic plan so you can follow it throughout the year. And always remember that life is short. Do your best to ensure that what you do now gets you to where you want to be.
Use Mashvisor’s investment property calculator to help you calculate your expected expenses and returns.