Real Estate Investing and Taxes

My friends and clients who know me well know I love real estate. Not the selling part (I leave that to my realtor friends), but the concept of the buying, the fixing, the investing part. In addition to being a great wealth-building medium, it can provide a steady income stream and tax deductions. Plus, you can leverage your money to purchase real estate (who ever heard of a bank willing to lend you money to purchase stocks?). While I certainly have no issue with investing in the stock market, I encourage you to also include real estate in your financial portfolio. Entire books and courses have been put together on this subject, but here are a few of my thoughts:

  1. What kind of real estate investing attracts you? Do you want to buy and hold; do you want to buy rental properties; or do you want to buy, fix up and sell? The direction will determine the team you want to assemble. Either way, you want a real estate expert who has your back, as well as a good tax professional!
  2. The “Fix and Flip” trend has seen a lot of press lately, thanks to several TV shows, and definitely has its merits. Like any investment, you really need to know the market, the financing, and have a good rehab team.  If that’s the direction you want to take, the IRS will consider it a business and tax it as such, where you report the activity on a Schedule C and be subject to self-employment taxes (15.3%).
  3. You can purchase a piece of property and hold onto it, hoping to re-sell it at a gain, like you would a stock. You obviously will need to know the market and be comfortable with the risks associated. The IRS will treat this transaction as a capital investment where you will report the gain or loss on your Schedule D form. The disadvantage here is that if you incurred a capital loss, your loss is only limited to other gains, and then the maximum loss you’re allowed is $3,000 per year.
  4. You can purchase a property in the hopes of renting it out for monthly rental income. That will require substantial research on the market, lots of spreadsheets and cash flow analysis, as well as a good, reliable team (realtor, property manager, loan officer and of course, tax professional). If that’s the route you’re going to take, the IRS will treat you as a landlord, and you’ll file a Schedule E form with your tax return. In addition to the regular expenses ordinary and necessary in operating a rental property (property management fees, travel expenses, supplies, taxes, interest), you can also deduct depreciation expense on the building portion of the real estate– what we call “phantom expense.” If you sell the property later on, you will have to pay capital gains tax on the gain, plus “recapture” the depreciation that was taken. Or, you can choose to do a 1031 tax-free exchange, where you sell the property and purchase another “like-kind” property. Again, always consult with the tax professional in your team!
  5. No matter which direction you take, please make sure you run the numbers and consult with your tax professional before making any financial decisions.

 

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