Why Tax Benefits Are One Of The Biggest Benefits Many Philadelphia Rental Property Investors See
One of the most significant benefits of investing in Rental Properties is the substantial tax rewards. The following are some of the tax benefits but remember that tax laws are highly dynamic, and you can exploit them to save more. Consulting an experienced Philadelphia Property Management Company, and a savvy Philadelphia Area Accountant will help you make the best choice.
Long-Term Capital Gains & Rental Property Investing
When you make a profit on a property sale, the IRS taxes the transaction. From 2018 onward, the IRS will apply your income tax rate if you hold on to the property for three years or less. For high net worth individuals, this rate can be too high. However, the much lower Long-Term Capital Gains tax rates apply to the profits of investors who hold onto their rental properties, for more than three years.
Deductions on Property Management Service and Travel Expenses
Most of the property management company expenses such as office supplies and mortgage interest are deductible. If your home is your office, you may be eligible to deduct internet fees, cell phone costs, mortgage interest among others. Ask your accountant if your home office qualifies for deductions.
You can also enjoy the standard mileage deduction. The standard mileage rate for 2018 is 54.5 cents per mile for business travel, as per the IRS. When you visit your rental properties, use this rate to calculate your business travel deductions. Don’t forget Philadelphia parking costs are also deductible. Meals and other associated costs to the trip may also be deductible.
Depreciation deduction allows you to deduct a portion of your rental property for a year. The depreciation of residential and commercial real estate is calculated by a 27.5 and 39-year lifespan respectively. Note that you will pay a "recapture of depreciation" tax; currently 25 percent on the profit you make from the sale of your rental property holdings. The good news is that your depreciation deductions over the years will be far more than that amount. You have also been able to invest the money in the best way you can since that time.
Avoid Paying the Recapture of Depreciation Tax
If you use the 1031 Exchange, you won’t pay the recapture of depreciation tax. The 1031 Exchange is an IRS code which allows rental property owners to defer taxes by selling their real estate and using the profit from that sale to buy another property. If you sell a rental property you bought some years back, you owe the IRS capital gains tax and recapture of depreciation tax on the profit. However, if you used the profit to finance the purchase of another "like kind" rental property through the 1031 Exchange, you will not pay the recapture of depreciation tax.
Note that if you use the 1031 Exchange, the deal must be closed within 180 days and the profit from the property must be deposited with a third-party intermediary until the transaction is completed. You will be liable to taxes on any portion of the profit that you withheld.
No FICA or Self-Employment Tax
The IRS does not consider income from rental property investments as "earned income." To fund their Social Security and Medicare, the two taxes most Americans pay are Self-Employment Tax or FICA (Federal Insurance Contributions Act). The employee and employer split the 15.3% tax of the FICA while a self-employed pay the total 15.3% in full. You may be exempt from paying this tax if you are a rental property investor.
How to Enjoy Tax Benefits on Real Estate
Consulting a Philadelphia property manager and an accountant on the tax implications of your rental property investments is the best way to enjoy tax benefits. It is even more critical now with the constant changes to tax laws. While Philadelphia rental property investments offer several tax benefits, you must follow the regulations to the latter to avoid running afoul of the IRS.
Grow Real Estate Investing Podcast Transcript:
Hi, I’m Joe White and this is the Grow Real Estate Investing Podcast
Last week I began doing a few podcasts that breakdown the advantages that real estate investing has over other forms of investing. This is 2nd one - a follow up to a biggie on Leverage. Definitely check out that podcast and article. I’ll have the links in the notes here.
So Leverage is a really big one, high money advantage, but real estate investing has another super power advantage. And it's an even stronger wealth generator than leverage. Think of it as leverage’s quiet bigger brother.
And that is the Tax Rewards that comes with real estate investing.
The bottomline is the government wants you to invest in real estate & they will give you a big pile of rewards if you do it. In fact the law is set up for real estate investors to avoid taxes.
So, Leverage’s quiet, booksmart older brother?
I say that because these tax advantages might be huge generators; but they still fly somewhat under the radar. I’m not 100% sure why that is; because the advantages are considerable, they are big returns, and on their own, they make real estate investing well worth it, over other forms of investing and they do it all by themselves.
I think tax advantages run under the radar some because most of us don’t see tax as something that we should owe.... Rather we often feel that someone is taking our hard earned money. So when we somehow don’t have to pay tax, we tend to not appreciate that fact as much as we should.
But Leverage will always be the flashy little brother, that catches our eye, driving the sports car with his bold earnings. Tax Advantages is the brother with his face in the ledger, always crunching the numbers. He’s the one you should have married, he’s the one your mom wanted you to marry; but you went after the sport car. That’s okay, Leverage is no slouch and he also is more fun.
Even when we hear seasoned, money smart investors, talk about the huge wealth power that tax advantages offers us, even their tone isn’t all that excited. Many of us use these tax advantages; but few of us truly appreciate them. But given the benefits, we really should! Because this is a crazy amount of money, so let’s all get excited!
So, Tax Advantages of investing in real estate:
1st, I’m not an accountant, I’m not a financial advisor, I’m not an attorney. I’m not a doctor, I’m not a lawyer. I’m just a real estate investor and a pretty opinionated one. Talk to them. They will cost you far less than they make you.
Real estate investing is a business. You own just one rental & the IRS sees that as a business and that gives you that ability to deduct expenses relating to that business: The tax, the insurance, the mortgage interest, the operating expenses, the repairs, the property management fees (and not just your property manager), basically anything needed to manage the property. Milage, paper, pens, the percentage that you use your home office, your internet, your cell phone, so on to manage this property. The list goes on and on.
Next Is Depreciation
Depreciation is where the government acknowledges that things are going to break, so they pay you for that upfront each year - even though they already paid you for that as a deduction, so this a phantom expense. You are getting paid twice. At this point the government is paying you!
No Fica No Self Employment Tax:Real estate earnings aren’t generally taxed as earned income, like a 9-5 job. That’s a 15.3% tax you and your employer share, so add another 7.65% on to this tax benefit pile.
Refinancing, or what I like to call: Tax Free Borrowing!
Say you borrow $100k to buy a distressed property for $50k, and to do $50K in improvements, so it's now worth $200K. You can refinance the property, pay back the $100k you owe and take an extra $75k, tax free.
Long term Capital gains or Short Term Capital Gains are the tax you pay when a property is sold. If you are a buy & hold investor, buying a rental property this is as much of a concern right now.
If you are planning on selling the property there is a 1031 Exchange; but that is involved enough that we’ll save that for another podcast and article.
To finish this up, most rental property owners, don’t pay tax on their rental income. Think about that for a moment. Don’t do it now, do it when opening up your next work paycheck. Take a moment to look at all that tax that was taken out and then ponder the tax advantages of real estate investing.
The next time you are racing down the highway, in that sport car with leverage think about his older brother.
Happy real estate investing everyone!