Real estate investments have many tax advantages that reduce your yearly expenses and maximize return on investment. This article will look at five reasons why investing in real estate is a better option than other investments such as stocks and mutual funds.
1. Real estate offers many tax deductions
Real estate offers several opportunities to lower your tax liability. For instance, you can deduct interest on mortgages for rental properties from your income and reduce what you owe in taxes at the end of the year. On top of this, you can also deduct property taxes, insurance premiums, maintenance and repairs, utilities such as heat, water, or electricity, and advertising expenses.
2. Real estate generates passive income
Real estate can also generate passive income. This means that while you hold a full-time job, your property is making money for you and providing tax deductions that reduce your taxable income. So when you invest in a rental property, you are not just diversifying your revenue streams but are also saving money.
3. Depreciation cuts your taxable income even more
Every piece of equipment in your rental property will depreciate as it gets older and loses its value. If you rent out real estate, depreciation allows you to write off any wear or tear that has occurred on your property for a year. This applies to assets such as appliances or furniture and others such as roofs and the like.
4. You’re subject to capital gains tax instead of income tax
When you sell your property at a higher price than you bought it for, the profit is considered a capital gain, which is potentially taxed at a lower rate than regular income tax. If you sell real estate after owning it for less than a year, these profits are taxed as regular income and can incur high costs that could reduce the return on investment. However, you may pay little to no taxes if you sell your property after owning it for over a year.
5. You can invest tax-free or tax-deferred
When you invest in real estate, it is possible to do so tax-free or tax-deferred. Tax-free means that there are no taxes applied when selling the property, and deferred means that you can delay paying taxes until later down the line. Tax-free or tax-deferred investments usually happen when you do a 1031 exchange.
A 1031 exchange involves selling an investment property you have owned for at least a year and buying real estate of equal or greater value within 180 days of selling your original property. In addition, both properties involved must be similar in use or nature for the transaction to qualify as a 1031 exchange.
Take the following example:
- You own a rental unit rented out for three years and is now worth $300,000. You want to sell this property and invest in a new one, so you need to do a 1031 exchange.
- If you sell and establish this property sale as a 1031 exchange you can find another real estate investment(s) within 45 days worth $300,000 or more. If you then close on the new property within 180 days of selling your previous property then you can defer your capital gain on the original sale.
Investing in real estate has a lot of benefits. Not only can it be a highly profitable venture, but there are also tax advantages that come with it. To learn more about investing in real estate, contact your financial advisor or accountant on how you should proceed with transactions involving real estate.
