7 Real Estate Investment Tax Benefits for Long-Term Wealth Building

1031 Pros
Mar 10
5 min read

Reducing your tax burden is a smart way to save money. Investing in real estate can make this possible. The right properties, when managed in the right way, can reduce the amount you must pay during tax season, and best of all, they can also generate income.

Here’s what you need to know about the tax benefits of real estate investing.

Is Real Estate a Good Investment?

You’ve probably heard the saying that 90% of millionaires grew their wealth via real estate. While that statement has been debunked as a myth, it’s true that real estate remains a solid investment choice, and you don’t need a lot of money to get started.

A real estate investment could be as small as one rental apartment or condo inside a building with hundreds of them. This property makes you money, as you rent it out and cash the checks from your tenant. This property also saves you money by allowing you to deduct plenty of expenses when tax time rolls around. And once it’s time to trade that investment for something else, you have another tax break to consider.

7 Tax Benefits of Real Estate Investing

While every investor is different, most people with investment properties use similar techniques to reduce their tax burden and hang onto their money. These are among the most popular tax benefits of real estate investing:

1. Depreciation

Some real estate starts losing money the moment you sign sales contracts. Other properties lose money due to wear and tear on vital infrastructure and equipment. These depreciation losses can suck money out of your investment, but there’s a silver lining.

The Internal Revenue Service (IRS) explains that depreciation on commercial property is tax-deductible. In 2023, for example, investors could deduct $1,160,000 as a maximum depreciation deduction.

Paperwork is required, of course. You must prove that your property has lost value, especially if you hope to take your maximum deduction. However, this is a powerful way to reduce your overall tax bill.

2. Maintenance

All investors must take care of their properties. For example, you might be asked to fix a leaking sink or repair a cracked floor that’s become a tripping hazard.

Routine maintenance that keeps your property in good operating condition is tax-deductible, the IRS explains. You can’t use this loophole to cover expenses that increase the value of the investment (like adding another bathroom). However, you can use it for the supplies and labor you’ll need to keep things working.

Remember to keep receipts for all of the supplies you purchase for maintenance. And if you hire someone to help you fix things, keep track of the amount you spend on salaries.

3. Management

Simply buying your property doesn’t end your obligation to your business. You must also tackle tasks like accounting, advertising, paying utilities, and getting insurance. The IRS explains that ordinary and necessary expenses like this are deductible in your taxes. You’re not required to handle each item alone to take the deduction, either. You can hire someone to help and deduct their wages too.

Keep good records of the amount you spend on supplies, as well as the fees associated with your employees. If the IRS asks you for proof that the amount you spent is valid, you’ll be prepared.

4. Mortgage Interest

If you borrowed money to purchase your property, you’re likely paying interest on the balance. The IRS says the mortgage interest payments you make are tax deductible.

Special rules exist that can limit how much you can deduct. For example, the new mortgage must have the same requirements for deductible interest as the one you used on your primary residence. However, if you took out a large loan, this is a smart way to reduce your overall tax burden quickly.

5. Property Taxes

Your real estate investment may incur both state and local taxes. You can’t opt out of them, but you should track how much you pay each year. The total could help you reduce your federal tax burden.

The IRS says that state and local real property taxes are deductible from your federal taxes. However, the taxes you can deduct don’t include those charged for local benefits or improvements that directly increase the value of your property. For example, if your local vicinity levies a tax on new sidewalks, you can’t deduct those from your federal taxes.

While this approach can save you a significant amount of money, the rules can be complicated. Work with a qualified accountant to ensure that everything works well.

6. Capital Gains Deferment

Some investors keep the properties they buy indefinitely. However, many others trade underperforming assets for better versions. For example, the single apartment you purchased may not be enough to make you a significant amount of money, so you may choose to sell it and buy a rental home instead.

In a typical real estate transaction like this, you’re required to pay capital gains taxes, and they can eat your profits. A solution exists.

A 1031 exchange is an investment tool that allows you to roll those tax obligations into the new property. You’re not required to pay them until you sell the new property.

The IRS explains that the taxes you owe aren’t forgiven. Instead, they’re deferred. However, if you never sell the property, those taxes never come due. When you die, your heirs won’t have to pay the taxes either.

7. Opportunity Zones

If you’re looking for a completely different way to invest in property and save money on taxes, opportunity zones could be a good fit.

An opportunity zone is a section of real estate that exists in an economically distressed community. By reducing tax obligations, officials hope that they can entice people to invest in these spaces and bring some financial development to people who need it.

The U.S. Department of Housing and Urban Development says the maximum benefit comes with holding the property for at least 10 years. At that point, the tax obligations you’ll face due to appreciation are completely forgiven.

In other words, you could purchase a property for a very small fee and improve it. As the property grows in value, your tax obligations increase (as you’re making money). However, if you hold the property for 10 years, you don’t have to pay those taxes.

If you have 10 years to spare and a little patience, this is an excellent way to increase your portfolio without facing a big tax bill.

Get Help With Exchanges

At 1031 Pros, we believe that a 1031 exchange remains one of the main tax benefits of real estate investing. With this approach, investors just like you can alter their real estate portfolios without incurring a huge tax bill.

We can help you with all sorts of transactions, including 1031 exchanges involving vacation homes. Contact us to get started today. We’re ready to answer any questions you have.