There are many reasons to invest in real estate but undoubtedly, one of the most important is the undeniable tax benefits. From depreciation to deductions, just try to find another source of income able to top these tax benefits!
1. Passive Loss Deductions. High income individuals will be delighted by the ability to offset gains in other areas by taking passive loss deductions from real estate. All expenses associated with real estate investments qualify including management fees, taxes, insurance, repairs, homeowner association dues, legal and accounting fees and even small office expenses. Just be sure to keep receipts and set up a tracking method.
2. Depreciation. Few things are more tax friendly than real estate; while the property appreciates in value due to inflation, improvements and/or market forces, it simultaneously depreciates in value according to Uncle Sam. The average depreciation schedule for most single family residential homes is 27.5 years which means you deduct a percentage of the price of the building (not land) in addition to expenses or other fees each and every year.
3. Interest Deduction. If you are using other people's money - including banks, hard money lenders or even personal loans - the interest is typically deductible. Since interest payments tend to be highest in the early stages of ownership, interest deductions are especially useful when building a real estate portfolio.
4. Income Tax Treatment. When you work for a living personal income taxes and FICA represent a significant tax burden. FICA alone equal 15 percent of wages for self employed individuals (employers match employee contributions for a total of 15% combined), however, rents collected from real estate are never subject to self employment taxes making them a favorable way to generate tax free profits for retirees and others.
5. 1031 Exchanges. There are very few investments that allow you to trade them in and purchase another without any tax consequences but real estate is one of the exceptions to the rule. Investors must follow specific criteria to qualify but it's entirely possible to roll profits from one property into another without generating any tax bills whatsoever - be sure to understand the requirements well into advance in order to avoid unpleasant surprises later.
6. Totally Tax Free. Personal residential property can generate up to $250,000 of profit completely tax free! Many people have been able to fund a significant retirement benefit from buying their primary residence at the right price then downsizing later in life and pocketing the profits (tax free!). To qualify, you must live in the property for two out of five years immediately prior to selling. Imagine the additional income someone could generate simply by buying low and selling high every five years - with zero tax burden.