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  • Writer's pictureHenry Riera

The Taxing Truth: The Reality of Taxes on Real Estate Investment

Real estate investing can be a lucrative business, but it's not all glitz and glamour. It comes with a number of challenges, and taxes are one of them. When it comes to taxes, real estate investing can be both complicated and costly. Unfortunately, many investors don't realize this until it's too late. Today, we want to educate you on the most important things you should know as an investor about taxes in real estate investing.

What Investors Should Know

Real estate investment taxes can be confusing, but they're an important aspect of the business. As an investor, you should educate yourself on how taxes work and how they can affect your investment. Here are some of the things you should know about taxes:

  • Property taxes are collected by the government from property owners. These taxes are used to fund public services such as schools, hospitals, and road construction.

  • Property taxes are assessed based on the market value of the land. The higher the market value, the higher the taxes.

  • Depending on the location of the property, taxes can be either high or low. For example, property taxes in Florida are particularly high because the state doesn't collect income tax and the lost revenue is offset by property taxes.

  • Tax laws are constantly changing, so it's important that you keep up with the latest developments. If you don't, it can lead to costly mistakes.

How Tax Deferral Works

One way investors can manage their taxes is through tax deferral. Tax deferral simply means postponing the payment of taxes until a later date. There are several methods for this, for example:

  • 1031 exchanges - This is a tax deferral technique that allows an investor to sell one property and buy another without having to pay capital gains taxes on the sale.

  • Opportunity Zones - These are designated areas that offer tax incentives to investors who buy and hold properties in these areas.

  • Depreciation - Investors can use depreciation to reduce their taxable income by deducting the cost of the property over its useful life. This can significantly reduce the amount of taxes owed.

Taxes on Capital Gains

Capital gains taxes are taxes paid on the gains from the sale of an investment property. These taxes can be a significant burden, especially for investors who sell their properties frequently. However, there are ways to minimize the impact of capital gains taxes. For example, investors can hold their properties for at least one year to take advantage of long-term capital gains tax rates, which are generally lower than short-term capital gains tax rates.

Deductible Expenses

Investors can also reduce their tax liability by deducting certain expenses. These expenses include:

  • Mortgage interest

  • Property tax

  • Repairs and maintenance

  • Property management fees

  • Utilities

  • Insurance premiums

  • Depreciation

It's important that you keep accurate records of these expenses to avoid problems during audits.

Losses From Passive Activity

Investors who own rental properties can offset their rental income against passive activity losses. These losses occur when rental expenses exceed rental income. They can be used to reduce taxable income and potentially result in a tax refund. However, there are limits to the amount of deductible passive activity losses, and investors must meet certain criteria to qualify.

Tax Implications of the Sale of Real Estate

Selling real estate can be a lucrative business, but it also has tax consequences. Investors who frequently sell real estate may be classified as dealers, which means they're subject to higher tax rates and self-employment taxes. To avoid these tax consequences, investors should hold their real estate for at least one year to enjoy long-term capital gains tax rates.

Foreign Investors

Foreign investors who invest in U.S. real estate are subject to different tax laws than U.S. citizens. These investors must file taxes with the U.S. Internal Revenue Service (IRS) and may be subject to withholding taxes on rents and capital gains. It's important for foreign investors to seek advice from a tax professional who is familiar with the tax laws that apply to them.

Tax Planning

Tax planning should be an integral part of any real estate investor's strategy. Investors should work with a tax professional to create a tax plan that minimizes their tax liability while maximizing their profits. Tax planning can include a variety of strategies, such as tax deferral techniques, deductible expenses, and losses from passive activities.

Taxes on Real Estate Investment

Real estate investment taxation can be both complicated and costly. However, with the right knowledge and guidance, investors can effectively manage their taxes and minimize their tax liability. As an investor, it's important to educate yourself on how taxes work and how they can affect your investment. Seek advice from a tax professional who can help you create a tax plan that aligns with your investment goals.

At Hanrot Capital, we know that the world of property tax can be complex and overwhelming. That's why our team of experienced advisors is here to expertly assist you every step of the way. With our trusted advice, you can confidently navigate the property tax terrain and take advantage of lucrative opportunities to improve your financial portfolio. Trust us to help you achieve your income goals and make informed decisions for a secure financial future.

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