Important Tax Considerations for the Real Estate Investor

There’s a very good reason that most of us never learned to be an accountant and leave our taxes to someone else every year: tax codes are complicated and confusing, not to mention extremely boring to most of us! However, as a real estate investor it’s important to become familiar enough with those that apply to your business in order to ensure you are making the best deals possible.

There are several misconceptions about currently existing laws or those that may not exist at all any more. Real estate tax laws vary between states and local districts, but the bare-bones knowledge is still required to realize your true profits from any one deal – structuring a purchase or sale incorrectly can severely reduce these, as well as open you up to additional tax liabilities you may not even realize you missed.

Some investors make the common mistake of purchasing residential real estate, fixing it up and selling it for profit without ever living there, and not understanding current tax laws regarding this activity. Many tax deductions and credits for real estate purchases are only applicable to those which are used as a primary residence. There are also capital gains tax implications and increased property taxes due to the lack of deductions for investment real estate.

However, if an investor purchases a home and lives in it for two years or more, this will result in a tax-free sale if proceeds are used toward another piece of real estate. This law was enacted in 1997 to encourage owners to continue owning, and have the ability to move to increasingly higher valued properties.

When a property is held for less than a year, such as is the case in flipping for a quick profit, proceeds are subject to short-term capital gains tax that equals normal income tax rates. When held for a longer period of time, the profits are classified as long-term capital gains, and taxed at a maximum rate of 15%. Of course, this is assuming you never lived in the residence yourself.

1031 exchanges provide a tax advantage to real estate investors in what is referred to as a “like kind” trade in property. An investment property sold can use proceeds to purchase additional income-producing real estate and defer any owed taxes. Funds from the sale are held by a facilitator, and up to three different replacement properties must be identified within 45 days of the original sale. Then, the investor has 180 days to close on one or all of these properties.

Also remember that many tax incentives offered when purchasing your residence are not available with investment purchases. However, if you properly structure a business entity to buy and sell properties, rent them out and repair them, there are business tax deductions that can be taken advantage of.

Always consult a tax professional before continuing with any type of investment purchase or sale to ensure you are not incurring undue tax liabilities. Having a trusted CPA and accountant are priceless when it comes to saving more of your own money!