As a property investor, a 1031 exchange could be one of the most profitable tax strategies you can utilize. Take a look at these 6 IRS guidelines to ensure you are on the right track when moving forward with a 1031 exchange.
This post covers depreciation, a powerful real estate tax benefit that can save you thousands each year. Find out how it works and how you can keep more money in your pocket come tax time!
Among the many benefits of being a real estate investor, the tax implications are incredible. If you’re just getting started, or simply want to make sure you have all your bases covered, we’re sharing three resources you can use to better understand real estate taxes, and maximize your benefits!
- Tax-Free Wealth by Tom Wheelwright. This book is the tax bible, the Holy Grail, the… you get it. Tax-Free Wealth is all about using the current tax laws to your benefit. As a real estate investor, you need to know how the tax laws work, and how they are designed to benefit you. Tom Wheelwright is one of the most knowledgeable tax accountants around, and this book totally transformed my business. If you’re trying to create wealth and minimize your taxes, you need to read this book!
- 10 Tax Deductions for Real Estate Investors. This blog post contains ten tax deductions you can take advantage of if you’re purchasing rental real estate. Take a look over this list and make sure you and your accountant haven’t skimmed over any important savings!
- How to Maximize Depreciation – Interview with Tom Wheelwright. On episode 22 of Investing in Real Estate, Natali and I sat down with tax genius and Rich Dad advisor Tom Wheelwright. Wheelwright shared how real estate investing can mitigate other tax burdens, how you can make sure you’re getting the most benefits out of your investments, and the importance of depreciation!
A 1031 exchange is a powerful tool that allows an individual to save on taxes after the sale of a piece of real estate. This tax deferral program permits the investor to sell a real estate property and then reinvest the funds in a property of equal or greater value. Doing so allows the investor to keep more money in their pocket, and defer all capital gains taxes. Here's a quick overview on how the process works:
First, the properties involved in the exchange must be held for either business or investment purposes. This information is proven by tax returns, including rental income, depreciation records, and intent. It’s important to have this documentation in place in case of an audit.
There are also regulations in place for the new purchase. The new property must meet the reinvestment requirements. This means the new property must be of equal or greater value than the property that was sold.
Additionally, there is a strict timeline that the investor must uphold. The investor has 180 days to complete the exchange. This begins on the day escrow closes on the sale. Leonard explains that it’s important to work with an accommodator, such as his team. You also must reach out to your accommodator before escrow closing.
Finally, the IRS requires that the investor identify their purchasing plans on day 45. The investor must describe the property or properties they are planning to use as the replacement in the exchange.
Taxes are an essential component in any business, and real estate investing is no different. Fortunately, there are enormous tax benefits in owning residential real estate. Being strategic about taxes year-round can totally change your experience and perspective on the tax code.
The first reason why real estate investing can help you save on your taxes is that real estate investments are tax deductions. The government wants to encourage investors to improve communities, and invest in growth. The way I look at it is, you can either write a $40,000 check to the IRS every year, or you can use that money to invest in a cash-flowing property. It’s a no-brainer!
Secondly, real estate depreciations work in your favor as an investor. This doesn’t apply to your primary residence, but investments are different. You can claim depreciation expenses on your investment properties. This can be an immense deduction, and any knowledgeable accountant will be able to help.
Additionally, some personal expenses can be business deductions. When your investing journey becomes a business, it is taxed as so. Businesses don’t pay taxes on the money they spend on business expenses. Any legitimate business purchases can be tax write-offs.
If you want to expand your knowledge on the US tax code, check out my interview with tax genius, Tom Wheelwright!
My favorite tax accountant Tom Wheelwright likes to say, “if you’re a real estate investor and you’re paying taxes, then you’re doing something wrong!” One of the top benefits of real estate investing is the enormous overall implication on your tax burden.
We aren’t CPAs, so please consult your own tax advisor. However, as you grow your portfolio, it’s incredibly important that you work with an accountant who understands real estate. Hear Tom Wheelwright’s tips for hiring the right accountant.
Here are ten deductions your tax advisor should be accounting for:
- Interest. This is one of the most important deductions for real estate investors. If you’re using some kind of loan to attain properties, the interest you pay every year is a write-off.
- Depreciation. The current tax code allows you to claim depreciation on each property for 27.5 years. Claiming depreciation is a powerful tool for mitigating your overall tax burden. For more on depreciation and how to calculate it, see this blog post!
- Repairs. We do repairs on all of our properties in order to make them into great homes for our tenants. And luckily these repairs are deductible in that tax year. Win-win!
- Local travel. If you live within driving distance of your rental properties, travel expenses count as business expenses. Keep track of your mileage, and receipts from renting vehicles.
- Long-distance travel. As you know, I’m a big proponent of purchasing properties across state lines. Airfare, hotel stays, and team meetings are all business expenses, and therefore are eligible write offs.
- Home office. If you have an office in your home used solely for business purposes, you can claim part of your home as a business expense. There are strict stipulations surrounding this one—your office must have a door, and it must be exclusively an office. A guest bedroom/office or home gym/office does not qualify.
- Employees. The whole purpose of the tax law is to encourage businesses to stimulate the economy. If you hire contractors or have people on staff to make your business run smoothly, you can write it off! The government wants to incentivize you to continue creating jobs.
- Casualty losses. This isn’t something you want to plan for, but in the event of a disaster, such as a fire or a flood, the IRS allows you to write a portion off as a loss.
- Insurance. Most investors think about building insurance costs into their expenses, but forget that insurance costs are a write off at the end of the year! Again, it’s a business expense, and the government loves to incentivize stimulating the economy!
- Professional or legal services. Any fees you pay to a property management company, lawyer, or other professional can be written off as business expenses.
If you’re serious about saving on your taxes through real estate, there’s one resource I can’t recommend enough: Tax-Free Wealth by Tom Wheelwright. If you can’t tell, I think Tom is a brilliant accountant!
Many successful investors who I’ve interviewed for the Investing in Real Estate Podcast have something in common—they struck inspiration after reading Rich Dad Poor Dad by Robert T. Kiyosaki. If you’ve read the book, this should come as no surprise. In fact, it’s touted as the #1 personal finance book of all time.
As a quick overview, Kiyosaki was raised by two different dads—one rich, and one poor. Therefore he grew up seeing differing viewpoints about money and wealth building. This situation gave him insight into investing, having your money work for you, and the importance of gaining control of your finances. There are six major principles in the book, all of which apply to real estate investing.
The rich don’t work for money. Truly successful people understand how to make their money work for them. Read: passive income. This is why I’m so passionate about rental real estate! Owning investment properties brings in rent checks every single month.
Why teach financial literacy? Many of us are not taught about how to make and manage money. We don’t learn financial skills in school, and many parents pass down their own limiting beliefs and fear-based ideals about money. Just today on the podcast, Natali and I discussed how we intend to teach our small children about money. We don’t just want them to think of money as something that mommy and daddy have, but rather something that they have the ability to create.
Mind your own business. In this section of the book, Kiyosaki writes about the importance of building your assets, and that we should all own our own businesses. That’s exactly what we do with rental real estate; it’s our business that allows us to build our net worth.
The history of taxes and the power of corporations. The majority of people hate taxes but this is only because they don’t understand how the tax law works, or how to make it work in their favor. Truly successful people take the time to gain an understanding of the tax law, and then reap the benefits. The US Tax Code favors entrepreneurs and real estate investors. There are incredible tax implications for owning rental real estate.
The rich invent money. Most people are of the mindset that they should work harder at their paycheck-based job, and try to save a little bit every month. The problem with this is that it takes forever, and the return on investment is low. But rich people build their financial intelligence, and gain a deep understanding of investments in order to create more money. That’s why at Morris Invest we’re all about ROI!
Work to learn—don’t work for money. For most people, job security is everything. But when you own cash-flowing rental real estate properties, your job is no longer all about the money. That’s true freedom.
Looking for more books? Check out my list, 5 Must-Read Books for Real Estate Investors.