Those seeking to diversify their portfolios and create passive income frequently turn to real estate assets. But did you know that real estate investing can also work as a tax shelter for other types of income?

The use of real estate investments to cut taxable income and perhaps even your tax burden will be covered in this article.

Rental Income as a Source of Taxable Income

Although rental income is treated differently from other types of income, it is nonetheless regarded as taxable income by the IRS. Rent is regarded as passive income, hence it is exempt from self-employment taxes.

Deductible property expenses including mortgage interest, property taxes, insurance, and maintenance can also be used to offset rental revenue. These costs can dramatically lower the taxable income produced by rental properties, making them a desirable investment choice for people trying to pay less in taxes.

Depreciation Deductions

Depreciation is yet another substantial tax benefit of owning rental property. Investors can write off the cost of the asset over the course of its useful life thanks to the tax break known as depreciation. In other words, for a specific number of years, you can write off a certain percentage of the property’s worth each year.

Rental real estate for homes over 27.5 years and for businesses over 39 years is permitted for depreciation under IRS regulations. This deduction can greatly lower the taxable income produced by rental properties, which is one of the main reasons why many real estate investors decide to hold rental properties.

1031 Exchanges

A 1031 exchange, often known as a tax-deferred exchange, enables investors to sell one property and buy another one of a similar sort without having to pay capital gains taxes. This means that if you reinvest the proceeds from the sale of a property into another qualified property, you can delay paying taxes on the sale.

Consider the case when you possess a rental property whose value has increased dramatically. You would normally be required to pay capital gains taxes on the profit if you sold that property. The payment of those taxes, however, may be postponed until you sold the new home if you used a 1031 exchange to reinvest the revenues in another rental property.

It is important to remember that 1031 exchanges are subject to tight guidelines and criteria. After 45 days of selling the original property, you must decide on a replacement property, and you must close on the replacement property within 180 days of the sale.

Tax Benefits of Real Estate Investment Trusts (REITs)

Real estate investment trusts (REITs) are an additional real estate investment option with the potential to reduce other taxable income. Companies that hold and manage real estate with an income stream are known as REITs. By law, they must pay out dividends to shareholders equal to at least 90% of their taxable profits, which can be a source of passive income.

The fact that REITs are exempt from federal income tax, provided they meet specific criteria, is one of the tax advantages of investing in them. As a result, stockholders will not be subject to corporate taxes on the revenue earned by REITs.

Furthermore, since REITs must transfer at least 90% of their taxable revenue to shareholders, they can be a great method to create passive income while possibly lowering taxable income.

A great strategy to produce passive income while perhaps lowering taxable income is through real estate investments. Rental revenue is handled differently than other types of income, and it is subject to deductibility of related expenses. The taxable income from real estate investments can also be decreased further via depreciation deductions and 1031 exchanges.

Last but not least, purchasing REITs can be a means to increase passive income while perhaps lowering taxable income. To properly understand the tax ramifications of real estate investing, as with any investment, it’s critical to conduct due diligence and speak with a tax expert.

Although real estate investments can be a potent instrument for lowering taxable income, they also demand considerable thought and planning. Partnering with a financial advisor and tax expert can assist guarantee that you’re making wise investment selections and utilizing all of the tax advantages available.

In conclusion, investing in real estate might be a wise move to take into account if you’re seeking for ways to lower your taxable income. The possibilities for rental income, depreciation deductions, 1031 exchanges, and REITs make real estate investments a potentially tax-efficient way to increase your wealth.

F2H Capital Group is a debt advisory firm specializing in negotiating the best terms for your commercial real estate projects. The company offers a range of financial products and services, including fixed loans, bridge loans, and construction loans across all asset types. Please contact us for any of your financing needs.