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Tax Advantages of Real Estate Investing: What Every Investor Should Know

Discover the tax advantages of real estate investing in multi-family homes and apartment complexes, including depreciation, 1031 exchange, and more. Learn how to maximize your ROI with Follow The Deal’s expert team.
Posted April 17, 2023
Tax Advantages of Real Estate Investing: What Every Investor Should Know

If you’re considering dipping your toes into the world of real estate investing, you’ve probably heard about the incredible financial benefits that can come from investing in multi-family homes and apartment complexes. But did you know that there are also some significant tax advantages to real estate investing?

In this article, we’ll explore these tax benefits and show you why investing in properties like multi-family homes and apartment complexes can help maximize your return on investment (ROI). If you’re interested in learning more about investing in these types of properties, we invite you to contact our expert team at Follow The Deal to discuss your options.

Depreciation

One of the most powerful tax benefits of investing in real estate is depreciation. Depreciation allows you to reduce your taxable income by spreading the cost of your investment property over a certain number of years. Think of depreciation like a car’s odometer: as the car gets older and accumulates more miles, its value decreases. Similarly, as a property ages, its value may also decrease, and the IRS allows you to deduct this “wear and tear” from your taxable income.

For residential properties, like multi-family homes and apartment complexes, the IRS typically allows you to depreciate the value of the building (not the land) over 27.5 years. This means that each year, you can deduct a portion of the property’s value from your taxable income, helping to reduce your tax bill.

1031 Exchange

Another valuable tax advantage in the world of real estate investing is the 1031 exchange. Named after Section 1031 of the Internal Revenue Code, this provision allows you to defer capital gains tax when you sell one investment property and use the proceeds to purchase another “like-kind” property.

Think of the 1031 exchange as a relay race: when you sell one property (pass the baton), you have a limited amount of time to identify and purchase a new property (reach the next runner) to avoid paying capital gains tax. This allows you to continually grow your investment portfolio while deferring taxes on any profits you make from selling properties.

To take advantage of a 1031 exchange, there are specific rules and timelines you must follow, but the potential tax savings can be significant. Be sure to consult with a tax professional or reach out to our team at Follow The Deal for guidance on how to properly execute a 1031 exchange.

Mortgage Interest Deduction

When you finance the purchase of a multi-family home or apartment complex with a mortgage, you’ll likely pay interest on that loan. Fortunately, the IRS allows you to deduct the mortgage interest you pay on investment properties, which can help lower your tax bill.

Imagine your mortgage interest as a highway toll: you have to pay it to use the road (finance your property), but you can deduct the cost from your taxes, making the journey (property ownership) more affordable.

Keep in mind that there are limits to the mortgage interest deduction, and it’s important to consult with a tax professional to ensure you’re taking full advantage of this tax benefit.

Pass-Through Deduction

The Tax Cuts and Jobs Act (TCJA) of 2017 introduced a new tax benefit for certain business owners, including real estate investors. The pass-through deduction, also known as the Section 199A deduction, allows you to deduct up to 20% of your qualified business income (QBI) from your taxable income.

For real estate investors who own properties through a pass-through entity, like a limited liability company (LLC) or partnership, this deduction can provide significant tax savings. Imagine the pass-through deduction as an express lane on a busy highway: it allows you to bypass a portion of your taxable income and reach your destination (tax savings) more quickly.

It’s important to note that there are income limits and other restrictions on who can claim the pass-through deduction, so be sure to consult with a tax professional to determine if you qualify and how to maximize this valuable tax benefit.

Bonus Depreciation and Cost Segregation

The TCJA also introduced changes to bonus depreciation, allowing investors to immediately deduct a larger percentage of the cost of certain assets. For real estate investors, this means you may be able to accelerate depreciation on certain property improvements, further reducing your taxable income.

To take advantage of bonus depreciation, you can utilize a cost segregation study. Cost segregation involves breaking down your property into different components, each with its own depreciation schedule. By identifying and valuing these components separately, you can accelerate depreciation on certain assets and maximize your tax savings.

Imagine cost segregation like sorting a bag of mixed candy: by separating the different types of candy (property components), you can enjoy the benefits of each kind (accelerated depreciation) more quickly.

However, cost segregation can be a complex process, and it’s important to work with a qualified professional to ensure you’re maximizing your tax benefits while staying compliant with IRS guidelines.

Tax Benefits of Real Estate Group Investing

By investing in multi-family homes and apartment complexes through a real estate group like Follow The Deal, you can pool your resources with other investors to take advantage of these tax benefits on a larger scale. Real estate group investing allows you to diversify your investment portfolio, spread risk, and access professional management, while still enjoying the tax advantages of real estate investing.

In conclusion, the tax benefits of real estate investing can be significant, especially when investing in multi-family homes and apartment complexes. From depreciation and the 1031 exchange to mortgage interest deductions and the pass-through deduction, these tax advantages can help you maximize your ROI and grow your investment portfolio more effectively.

If you’re interested in learning more about real estate group investing and how you can take advantage of the tax benefits offered by investing in multi-family homes and apartment complexes, we invite you to contact our expert team at Follow The Deal today. We’re here to help you navigate the world of real estate investing and ensure you’re optimizing your investments for the best possible returns.