Investing in real estate continues to be one of the best ways to grow and build wealth, and simultaneously to cut taxes. Investing and owning real estate comes with certain benefits which include the ability to recover the cost of income-producing property through depreciation and to defer profits from real estate investments and borrow against real estate equity to make additional investments or for certain other purposes. Fortunately for people who invest in real estate, there are several techniques that can be used such as a cost segregation strategy which will reduce your real estate tax burden and therefore maximise your returns.
Make use of Depreciation Deduction
You can recover the cost of income-producing rental property through annual tax deductions called depreciation. The Internal Revenue Code has made Depreciation Deduction an allowable deduction for deterioration and wear and tear. Depreciation is therefore a valuable tax deduction, residential properties are depreciated over 27.5 years while commercial properties are depreciated over 39 years. Investors can make use of cost segregation which makes use and identifies components of the property that can be depreciated over a shorter period, therefore accelerating your depreciation deductions and simultaneously reducing taxable income.
Taking Advantage of 1031 Exchanges
Internal Revenue Code, Section 1031 which is often referred to as “1031 Exchange” this exchange enables investors to defer their taxes by being able to sell one of their investment properties and using the equity therefrom to purchase another property or multiple properties of equal or greater value. The only requirement that is needed for the 1031 exchange is that this will need to occur within a specified period of time.
This 1031 exchange can apply and include several different types of property, however, the majority of these exchanges apply to real estate. This tool is useful for real estate investors as they can continuously develop and grow their property portfolio without being hindered by tax, therefore using this exchange enables them to defer taxes and increase their wealth.
Borrowing Against Home Equity
Property investors who have a large property portfolio and sizable equity may choose to refinance their properties and receive equity to make additional investments, to improve their home, or for other purposes. These regulations however do differ from state to state. This strategy however is deemed to be more risky, however, for those investors who can bear the burden of additional debt, it can assist them to build their portfolio and their wealth without having to enter into a 1031 exchange or to sell a property.
Invest in Opportunity Zones
The government allocates certain zones, which was created through the 2017 Tax Cuts and Jobs Acts, which were implemented to encourage economic development in low-income areas or zones, called opportunity zones, to encourage economic development in distressed communities. These zones offer real estate investors the opportunity to have significant tax incentives. Therefore encouraging the investing of capital gains into these Opportunity Zone Funds enables investors to defer and potentially reduce their taxes on those gains. The other added benefit of these zones is that if a property investor has the investment for a certain period, they may additionally qualify for added tax benefits which may include partial or complete elimination of capital gains taxes on their investments.
Remain informed about Tax Law Changes
Tax laws and regulations related to real estate are often adapted and changed therefore these property investors need to remain informed and adapt their strategies accordingly. Remaining informed and consulting with professionals in the industry will assist investors to remain compliant with the laws and therefore assist them to continue to capitalize on new opportunities as they develop. Remaining proactive with your tax planning will help investors anticipate and mitigate potential tax implications of their future transactions.
Savvy investors should use and utilize a combination of strategies to leverage legal tax incentives that the government provides to grow their portfolios and generate more wealth. Investing in real estate can greatly build wealth and simultaneously reduce taxes, which can be done by various means. By adopting and implementing a strategic approach that integrates various techniques and considerations, such as taking advantage of Opportunity Zones and tax credits, investors have several opportunities at their fingertips to place them in a better tax position and therefore maximize their returns.
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