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Secret Real Estate Tax Breaks Used By the Rich
News Flash: Investment Real Estate is the single most tax-advantaged asset class in the U.S!
This is Why: You can buy and hold rental properties to create streams of passive income that flow into your pocket every month (on which you can legally pay no tax), then sell the property for a gain down the road (on which you can legally pay no tax, again), and in the meantime generate paper losses even if your property appreciates in value and cash flows positive every month (and those “phantom losses” can potentially be taken against other forms of income as a write off).
Sound too good to be true?
Not only is it true, it is completely legal and, in fact, all these “real estate tax loopholes” are simply government incentives designed to encourage you to buy and hold rental property. So, this is your reward for doing what the government wants. Nice, huh?
The only “catch” is that you have to first know what these loopholes/incentives are and, secondly, you have to execute them properly (with careful compliance) to ensure you do it all legally and correctly.
Now, the wealthy have extremely well paid CPAs who understand exactly how all of these legal tax loopholes work and who help them maximize every one. We think you should know how they work and be able to maximize them too as they are one of the core benefits of investing in real estate.
So, while we are not giving you any tax advice here, and while you must consult your own CPA about your individual situation and applicable law, we are going to do two things:
Below, we will summarize some of the main real estate tax loopholes.
But first, we are going to introduce you to New York Times Best-Selling author and legendary Tax Strategist to the Rich, Diane Kennedy who, in a private webinar for the Maverick community (that you can view on the left), pulls back the curtain and shows exactly how her wealthiest clients are strategically using all of these real estate loopholes…and how you can too!
Tax Benefits of Residential Investment Property
Residential Investment Property (if bought and held, not fixed and flipped) is the only asset class that allows you to take ALL of these tax benefits:
Write Off Your Operating Expenses.Property management fees, insurance, repairs (not capital improvements) and property taxes are all deductible.
Write Off Your Mortgage Interest.You can also deduct your Mortgage interest. If you make interest-only payments on your loan, your entire mortgage payment is deductible.
Depreciate the Value of Your Property (Structure, not Land) Over 27.5 Years.Even if your property is going up in value, the government allows you to ‘depreciate’ it! They do not let you depreciate land however, so you need to break out the cost of the land and then depreciate only the property structure on a 27.5 year straight-line schedule. Let’s say you buy a new or completely renovated rental property for $325,000. If you determine the land to be worth $50,000, you would subtract that out and that leaves you with $275,000 as the value of your structure, which you can then depreciate over 27.5 years. So, if you divide $275,000 by 27.5 that comes out to a $10,000 annual "loss" you can take against your income from the property for each of the next 27.5 years. This is referred to as a "phantom loss" because you didn’t actually lose anything. Pretty cool, right?
Accelerate Your Depreciation on Certain Items with Cost Segregation.In addition to the straight line depreciation of your property structure over 27.5 years, there are a number of "personal property" items that you can break out and depreciate on accelerated schedules. For example, if you have a brand new microwave, stove, flooring, HVAC, etc., in your rental property, these items can be depreciated over a much shorter period (7-15 years) so you can legally take those benefits sooner and have your initial paper "losses" be even greater.
Take Your Left Over "Phantom Losses" Against Other Forms of Income.The IRS says that you can take up to $25,000 per year of real estate losses against other forms of income (such as earned income from your job). Let’s say you make $100,000 per year at your job, and that you were able to accumulate $25,000 of left over "phantom losses" that you could take against that earned income. That would reduce your taxable earned income from $100,000 down to $75,000. So, if you were in the 28% tax bracket that would be an annual tax savings of $7,000! Now, your ability to take $25,000 of real estate losses against other forms of income phases out as your income rises from $100,000 to $150,000 and if you make over $150,000, you cannot take any of your real estate losses against your other forms of income, unless you can qualify as a "real estate professional" for tax purposes.
The "Real Estate Professional" Status: The Ultimate Tax Loophole for Real Estate Investors.The holy grail of real estate tax benefits is the "Real Estate Professional" status. The IRS is making it tougher to qualify, so make sure you are working with a qualified CPA to ensure you have proper documentation if you want to try. These are the benefits:
- If you have left over phantom losses after taking them against all your rental income from your properties, you can take the remainder against income you earn from other unrelated sources, including earned W2 income from a regular job.
- There is no income limit so you can do this regardless of how much income you make.
- Only one spouse needs to qualify as a real estate professional if you are married and filing jointly in order for the real estate ‘losses’ to be written off against income from both spouses.
The Legendary 1031 Exchange.A "1031" or "Like Kind Exchange" allows you put all of the proceeds from the sale of your property into buying another "like-kind" property (or properties) of equal or greater value. You can "exchange" properties without triggering the capital gains tax and depreciation recapture that would normally be due on sale. The amazing thing is that the government allows you to continue to exchange and exchange and exchange for your entire life and then, at death, the deferred depreciation recapture and capital gains are both automatically wiped out when your heirs inherit the property! There are important formalities and compliance requirements for executing a 1031 exchange (including the use of a Qualified Intermediary) and timeframes that you must adhere to, so be sure you are working with a professional to execute the transaction properly.
DISCLAIMER: We are NOT tax professionals, this is not tax or legal advice, and tax laws are constantly being changed and revised and may change the day after you read this. So, this is for informational purposes only, and it is your duty to consult with your own tax professional about your individual situation and the most updated applicable laws before attempting to implement any of the content in this post.