For Beginners: Effective Tax Strategies for Commercial Real Estate Investing
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Commercial real estate investing is one of today’s most common ways to grow your wealth and positively impact your financial future over the long term.
Commercial real estate, as a result, offers several benefits, including several tax advantages compared with other asset classes. However, should you not navigate these tax advantages correctly, they may very well turn from positives into pitfalls.
Here’s what you should know about some of the most effective tax strategies for commercial real estate investors.
Tax-Saving Strategies for Commercial Real Estate Investors
As a real estate investor, you’ll always look for ways to minimize your tax liability and maximize your cash flow. The tax rate on real estate investment income can vary depending on its income type.
For example, capital gains are taxed at a lower rate than ordinary income. However, if you structure your investments properly, you can minimize your overall tax liability. There are several strategies that you can use to achieve this.
#1 – Capital Gains Are Taxed Differently
Capital gains are taxed differently than ordinary income. When you sell a capital asset, such as a stock, bond, or piece of real estate, you may have to pay taxes on the sale. The short-term tax rate on a capital gain can be as high as 20%, depending on your tax bracket. However, there are ways to avoid or minimize capital gains taxes.
One way is with what’s called a 1031 exchange, which allows you to sell a property and reinvest the proceeds into another property without paying taxes on the sale. Real estate investors often use this when they sell a commercial property and reinvest the proceeds into another property.
Another way to defer capital gains taxes is to hold the asset for more than one year. If you hold the asset for more than one year, you will pay long-term capital gains taxes, which are lower than short-term capital gains taxes.
#2 – Real Estate Investment Tax Deductions
Another way to save on taxes is to take advantage of deductions. The mortgage interest deduction is a common one that many property owners take advantage of.
You can also deduct expenses related to the ownership and operation of the property from your business income. This can significantly reduce your overall tax liability.
Additionally, many tax incentives available to real estate professionals can make investing in real estate even more advantageous. One of the more notable tax incentives is the pass-through deduction, which allows you to deduct a certain percentage of your qualified business income from your personal income taxes.
#3 – Tax Credits for Real Estate Investors
As a real estate investor, you may be eligible for certain tax credits that can save you money on your taxes. These tax benefits can help offset your investment costs and make investing in real estate more affordable.
The federal tax credit for investing in real estate is one of the most popular. This credit allows investors to deduct a certain percentage of their investment from their taxes. This can be a significant tax benefit, as it can reduce your tax liability.
There are also some tax credits for investing in real estate in certain rural or less desirable areas as part of a revitalization program. To take advantage of these tax benefits, you should consult with a tax professional to ensure that you are eligible and that you understand the requirements.
#4 – Real Estate Investment Trust (REIT) Tax Benefits
Real estate investment trusts (REITs) offer many tax benefits, making them an attractive investment for those looking to invest in real estate without worrying about property management. One of the biggest benefits is that REITs are not subject to capital gains taxes, which can lead to significant savings for investors.
In addition, REITs are often eligible for special tax treatment, such as a lower tax rate on dividends paid out to shareholders. This can make REITs a more tax-efficient way to invest in real estate than other methods.
#5 – Using the Depreciation Deduction
The depreciation deduction can be a powerful tool for rental property investors to reduce their tax liability. When you own a rental property, you can deduct a portion of the cost of the property each year as it "depreciates" or loses value over time. This deduction is taken against your income, which reduces your overall taxable income.
The depreciation deduction can have a major impact on your cash flow. By reducing your taxable income, you may be able to increase your cash flow by hundreds or even thousands of dollars each year. This extra cash can be used to reinvest in your rental properties or to cover other expenses.
#6 – Use a Pass-Through Deduction
As previously mentioned, a pass-through deduction is a tax deduction that allows business income to be taxed at the individual rather than the corporate rate. This deduction is available for businesses such as sole proprietorships, partnerships, S corporations, and LLCs.
#7 – Utilize Carried-Over Losses
A carried-over loss is a tax deduction that can be used to offset income in future years. This is often used in commercial real estate when a property is sold for less than its original purchase price. This is sometimes called a capital loss carryover.
Work With a Financial Advisor to Comply With IRS Requirements
When you invest in the stock market or real estate, you’re liable to pay taxes on the profits that you cash out. When it comes to investing in commercial real estate, there are a number of ways to reduce those taxes and get more bang for your buck. The right tax strategies can help mitigate the amount of taxes you owe when selling properties.
The IRS maintains very strict rules on how much tax you have to pay and what deductions you’re allowed to take. While tax laws change every year, there are specific tips and tricks for people who invest in commercial real estate. These strategies can help lower the amount of tax you owe from your CRE investments.
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