Tax liabilities can add up to a significant amount for real estate professionals, and taxes can easily drain the profit people make in their deals. Not to mention, the idea of taxes both in and out of real estate is commonly known to overwhelm people.
However, there are ways to mitigate tax liabilities in the real estate world by utilizing some knowledge and ensuring that certain methods are applied.
This article will delve into how tax liabilities can be reduced by real estate professionals leveraging real estate activities in property deals.
Minimizing Tax Liabilities In Real Estate By Leveraging Real Estate Actions
The sale of a property with high profits often comes with a large tax bill and people are often confused about their real estate professional tax status, and how to deal with the large bill. There are ways of leveraging real estate actions to minimize the tax liabilities and to ensure maximum profit.
Depreciation Deduction
Depreciation refers to the deterioration of a property over a significant period of time and the cost taken on for these properties can be recovered through tax deductions. The IRS has a strict policy of determining depreciation of a rental property over a period of 27 and a half years, and fixtures within the property to have a depreciation period of 15 years.
Depreciation often results in the loss of value to a property as over time a property will lose structural integrity and have damages on it, but being able to prove that the owner has made contributions to keep it in the best shape possible helps in gaining deductible taxes. Homeowners with multiple properties will be helped if they utilize property management software to help them keep track of everything altogether.
Mortgage Interest Deduction
Mortgage interest is another large and significant tax deductible if done correctly by homeowners who show up on their tax returns. The highest amounts for these payments are in the earlier years and slowly scale down as the mortgage is paid off.
1031 Exchanges Advantage
Named after Section 1031 of the IRS code, this exchange allows property investors to defer the taxes from the sale of a property by reinvesting the equity into another property that has an equal or higher value.
Property Requirements
This process has a very strict time period and must be done within a certain time period. There are a few conditions for properties to meet the requirements of a 1031 exchange:
- The value of the next investment property must be equal to or more than the value of the property previously sold.
- The property transaction must be of the same kind, meaning it has to be a real estate property.
It should also be noted that only the property is subjected to the 1031 exchange transaction and any physical property such as fixtures does not count toward the exchange. The property itself must solely at least equate to the value of the previously sold property.
Regulations for Investors
An investor joining in on a 1031 exchange transaction must also be qualified to be a part of the deal, which is primarily done by holding the net proceeds from the property that was sold off. The investor is then subjected to two different deadlines:
- The intermediary or investor must submit a list of qualified replacement properties to reinvest the money into, all of which fall within the rules that determine how to select the properties. This must be done within 45 days of the sale of the property.
- The investor must also return an aggregate valuation of qualifying replacement assets within either 180 days of selling the last property or within 180 days after the tax return date. This is based on whichever comes first.
Using Home Equity to Borrow
Investors who do their investing wisely, manage to build up a large amount of equity which can be used to refinance towards additional investments, improving their home, or for other real estate purposes. For investors that manage to maintain their portfolio so well in this real estate market, they will know that the rules for this kind of financing vary from state to state.
It should be noted that this strategy comes with its own fair share of risks. However, those who can manage their finances and handle the additional debt will find it to build wealth for them at a faster rate.
Conclusion
Mitigating the taxes on a property sale is something on the mind of every home seller and even agent. However, these methods need to be done strategically and with a methodical approach.
Since taxes are governed by law and are strictly looked upon at all times, they need to be done carefully to ensure all means of real estate compliance is met, and that no law is broken. Otherwise, the IRS or the other parts of the government can come down upon the deals and dissolve them. Not to mention, they will also pin a larger tax return on you.
