What Does An Investor Need To Know About The Tax Benefits of Real Estate Investing
Do you want to know if rental income counts as earned income & find out other questions about tax deductions? You’ve opened the right article then! We’re telling you here what taxes are deductible from your yearly income & how you can use them properly in various scenarios. We’re also doing some math to make it more understandable.
Important! When you’re reading the article, you should remember that all taxes & their filing are not as straightforward as we present & they are full on nuances & intricacies, mostly concerning conditions of application, applicable amounts of annual income & connected tax (at low & high ends), periodicity of taxation & filing & tiers of applying, as well as areas of applying (as you must already know that not all taxes are equal on the entire US territory, especially in its overseas regions). So in all cases, it is advisable to consult a tax attorney in your area, who knows the current data & can give you calculations & pieces of advice according to the current situation.
How rental property tax deductions work
The tax deductions we are speaking about here are connected to rental property deductions. That is, you shall be a landlord, who earns income from possessing a rental property or a land plot. It is considered a commercial property from the point of view of the IRS. And when you’re running one or more such businesses, in order to normalize the tax load on you & other landlords like you, making such a business model more lucrative for investors, IRS currently offers several types of tax deductions, which you can utilize to leave more cash on hand.
The items of your expenses for running a landlord business that you can deduct from your taxes as of 2021 in the US are:
- cost of maintenance, upgrades & repairs
- fees to a property management company (should you hire one) or the expenses for the organization & running of your manager office (should you establish it yourself)
- insurance for your commercial property
- mortgage interest (should you use a bank loan to finance your purchase)
- property taxes.
Let’s say you have an object of $500,000 cost, which has 10 one-family apartments, every one of which generates you $550 rental income per month. Additional gains from rentals are $5,000 annually (for extra services like carpet cleaning, room service, laundry, parking, etc.). Annually, thus, you earn $71,000. And you have operating expenses equal to $30,000, which leaves you with $41,000 pure income. Of those 30 thousand, you have the so-called ‘qualified expenses’ of $15,000. They would include advertising, fees for an attorney & accountant, office space, business equipment, work travel, education, improvements connected to energy efficiency, dues you pay for being in some official homeowner’s association, professional subscriptions & more. Thus, you can deduct these $15,000 from your annual taxable income, which will make it 71-15=$56,000.
Needless to say, you have to meticulously keep all records, documents, contracts & receipts that prove those qualified expenses in the case if you’re audited by the IRS.
Tax benefits of rental property counted & considered one by one
Now let’s look at the list of other rental properties taxes deductions, which you can also use in your business.
Alternatively known as ‘amortization’, depreciation is how your entire commercial property gets depreciated from 100% to 0% of its cost from the point of view of accounting. The IRS establishes various times for depreciation, which is 27.5 years for residential properties (usually understood as premises, where a person or family regularly lives & does not let it for lease) & 39 years for commercial objects. Your object of $0.5 million will be depreciated in 39 years, each year for $12,820.51, which is tax-deductible.
Surely, from the market point of view, your property doesn’t go anywhere after it’s been used for 39 years – you can still sell it, in most cases, even for a bigger price you have bought it.
Also, what you invest in maintaining your property (a.k.a. general improvements) is also depreciated but in other terms that sounded – some improvements may have 1 year, some 5 or other terms. Consult with your tax attorney for exact numbers of rental property tax deductions. These improvements would include rebuilding a place, changing the leaky roof, adding more rooms or storeys, making a parking lot instead of lawn, changing floors & other expenses, which configure the condition & cost of the real estate.
You can deduct up to 20% of your qualified business income from your personal taxes. And you don’t have to be a sole proprietor of the object – you can also own it through partnership, S Corp, or LLC. This perk (enacted by the Tax Cut & Jobs Act of 2017) will cease to exist in 2025, so you should hurry up deciding on owning your first property to use it (if you still aren’t). Thus, given the example numbers above, your rental income is $56,000 & you can deduct $14,200 annually (this scheme presupposes the lowering of the annual income for the annual qualified expenses).
There are 2 types of them: short-term & long-term. The first occurs if you own a property for less than 1 year & 1 day before selling it. In this case, taxes paid are high – they’re counted as a regular income & account from 10% to 37% (depending on the particular amount of yearly gross income). In the second case, the taxes are lower & account from 0% to 20%. If your annual income isn’t going over some defined threshold, you may not pay any income tax at all, which is a point of high interest for many landlords. For instance, your spouse & you together make below $75,000 a year (let’s say, the entire revenue you both have is the one you get from renting a property). Then your long-term capital gain tax is 0%. Logically, you might be interested in holding a low-profit real estate object for a longer time than 1 year & 1 day before selling it to save on the capital gain tax – but that won’t matter if you sell it for the lower or same cost.
This tax incentive was put in place by the government to encourage landlords to buy & own new properties after they sell old ones. The cost of a new one should be the same or more than the one, you’ve sold. So if you’re not cashing out the money from the sale, you pay 0% tax under the 1031 incentive. From the taxation point of view, you simply swap the properties. But it’s a complicated program with many conditions & tiers, so you should better consult a tax attorney.
Some US territories are defined as the ‘opportunity zones’ – disadvantaged or low-income lands (defined by the Tax Cut & Jobs Act of 2017). If you’re one of the investors in such territories, which you can do by buying shares of the special fund, you can use this tax incentive to lower your taxes until 2026. Although you have slightly more than 4 years to enter the program, its benefits will apply for you for as long as you hold the share (before selling it). The milestones are 5, 7 & 10 years of owning. After reaching each milestone, you can deduct 10%, 15% & 100% of your long-term capital gains respectively. As this is also a tricky & complex incentive, we highly encourage you to consult a tax attorney.
No-FICA tax self-employed.
A.k.a. Payroll tax, this incentive allows you not to pay income tax when you’re working as a self-employed person while also being a landlord.
Let’s simplify the understanding: you are a freelance programmer who earns $60,000 a year. Normally, you have to pay 15.3% tax on personal income ($9,180 a year) & your employer portion of taxes – Medicare & Social Security. If you use the Payroll tax, you won’t have to pay the 15.3% tax for this earned income & you only pay the employer portion of taxes – for as long as you pay other taxes as a landlord. Although, in the combination with other tax deductibles, which you might want to use, this might not work in full or partial. For instance, when your gross annual income is bigger than a certain sum, you may not be eligible for exemption from the long-term capital gains on rental property tax.
Conclusion on rental property taxes
Now you know the answer to the question, does rental income count as earned income. And if you wisely & meticulously use all applicable provisions of current tax legislation, you may significantly optimize your annual tax expenses. Although some incentives end in 2025/2026, you still have years to enjoy the deductions legally. Finally, what you have to know is that being a landlord is tax-efficient in the US in the long run.
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DGY is a real estate investment and property management company. Our experts have an impressive experience in turning businessmen into smart real estate investors. We collect limitless opportunities throughout the world’s best real estate markets and help our clients implement the best deals. We take care of all due diligence and customize documentation while your income grows. We also provide you with property management services so you can forget about the tiresome maintenance of several objects and entrust this process to professionals.
Investment advice and recommendations
DGY is an investment company that takes care of every client and helps them become successful investors. With the help of an investment experience and a well-thought plan, we will help you examine the market, choose a strategy specifically for you or your business, and calculate future costs to start making money with real estate investment.
In order to invest in real estate, you should consider how you will run your management in Ukraine. DGY will help you eliminate all possible pitfalls at an early stage as a personal project manager will be assigned to your case. They will assist you in choosing the project according to all required objectives.
DGY Investments takes care not only of purchasing property but also renovating an existing one. With the help of a thorough plan and estimating, we will thoroughly prepare a property for sale. Our professionals evaluate an investment property and create a strategy that includes the costs for renovation, possible taxes, fluctuations on the market, etc. Therefore, our clients are able to resell the renovated properties in Ukraine with more than 15-20% profit from the initial price.
Before our clients decide to deal with real estate investing, they consult with our experts concerning details such as the necessary documents needed to purchase a property and successfully run all the processes connected to it.
Therefore, if you are eager to invest in Ukraine, it’s essential to have all the paperwork done correctly, and that’s the moment when our team of experts takes care of this step. DGY Investments helps investors buy real estate property, manage the paperwork, start preparing relevant documents for purchasing realty in Ukraine, and close the deal successfully.
Real estate investment opportunities in Ukraine
When an investor decides to invest in real estate in Ukraine, the most affordable way to attain stable passive income is through buying residential real estate. Investors can expect to receive a regular monthly payment from their tenants at a fixed monthly amount, unaffected by inflation or other unforeseen circumstances. The amount of rental income will vary depending on the size, type of property and location. For example, buying an apartment in Ukraine’s capital Kyiv is beneficial to investors due to offering a large working population, central location and affordable prices. Hence, the minimum price of renting a decent one-bedroom apartment in Shevchenkivskyi District will be around $1000 per month in 2021, followed by Pecherskyi District with a cost of $850 per month. Besides, investing in real estate in Ukraine annually brings clever investors up to 15% of yield, attracting many business people every year.
Properties for investments in Ukraine
Ukraine has a giant sector for real estate investing. Businessmen who come there all over the world often choose between investing in residential and commercial properties. The main advantage of buying property in Ukraine is the affordability of prices on the houses and apartments. For instance, if you invest in real estate in a historical district, a luxurious apartment will cost you around $80k only.
How to invest in Ukrainian Real Estate
In order to invest in Ukrainian real estate, you should take into account a list of crucial factors. The first one is to choose what kind of realty you are going to invest in: residential or commercial. It is vital as it should comply with Ukrainian real estate law. The second tip is to identify the purpose of purchase in order to make a strategy for the property. For instance, you may purchase the property for your own use or buy it for lease. The next step is to calculate the taxes and what kinds of taxes are payable during the purchase, owning, or selling. Also, to invest in real estate properly, you should keep in mind currency control rules in Ukraine to sell a property and get a higher profit.