Investing in real estate could be a sensible choice if you’re looking to build wealth and expand your portfolio. There are solid returns to be found and it’s a popular choice for those looking to retire.
Navigating the complexities of tax law can be a daunting task. However, it’s essential to get the basics to ensure you’re paying the right amount of tax.
We’ll dive into the types of taxes you can expect to pay on real estate, the different types of property investments available and how you can make your investment go further with our top tips on being tax efficient.
Let’s get started.
Taxable income on real estate
Before you invest in real estate, you should know which kind of taxes any income you make might be hit with. Let’s go into the different types of tax you can expect to see for real estate properties.
If you have tenants in a property, the rental income you generate will be considered taxable. This means you’ll need to declare the income on your tax return each year and put aside money to pay income taxes.
There are a few ways to reduce income tax liability through different investment structures and deductions, which we’ll talk about later.
Capital gains tax
If you buy a second home to rent out or as a holiday home, you could face capital gains tax (CGT) if the property appreciates in value.
CGT rates vary depending on how long you hold the property for. If you sell after less than a year, the short-term rate is the same as your income tax rate. For anything over a year the rates are either 0%, 15% or 20%, depending on your personal circumstances.
If you’ve inherited a property from a loved one that’s passed away, estate tax may be due. This is tax on the value of the individual’s estate, which often includes property. Estate tax is currently levied at 40%.
If you’re worried about the estate tax, the reality is it only affects a small number of people. The federal estate tax only applies if the assets are worth more than $12.92m, as of 2023. On top of that, most states don’t have laws in place for estate tax.
Understanding the different real estate types
Understanding the different types of real estate investments is important for investors looking to build a diversified real estate portfolio. Here are the most common types of real estate available on the market.
This is the most common type of asset class for most individuals to invest in. Many people choose a residential property to create a nest egg for retirement.
It’s worth noting that these properties are often subject to state and local regulations. They may also require regular upkeep and maintenance, depending on the age and build of the property.
Anything used for business purposes, like an office or warehouse, counts as commercial property. The tax implications of these are slightly different to residential properties and usually need more up-front cash to invest.
There can be great returns found in commercial property if you’re looking to make an income from this asset class, as well as write-offs and deductions to further reduce your tax liability.
Real Estate Investment Trusts (REITs) are professional companies that own and invest in real estate. Investing in a REIT means buying shares in the company rather than the property itself, which is handy if you’re not interested or experienced in managing multiple properties.
As REITs are a company, they’re subject to swings in gains and losses, whereas a property tends to steadily increase in value. Investing in a REIT depends on your risk appetite and what type of returns you’re looking for.
Is your head spinning from all the different options and you don’t know where to start? Get in touch today to find out how our expert team can help you with your taxes.
Top tips for real estate taxes
Now you’ve got the basics of real estate taxes and types of assets available to invest in, here are our top tips for ensuring you can stay on the right side of the tax man.
Here’s what you need to know.
Keep records up-to-date
Keeping hold of documentation makes sense for any investment, especially taxes. Be sure to track your expenses and any income gains for your real estate investments including repairs, management fees and renovations.
You’ll also need to keep track of your rental income and any other sources of income related to your investments. You can make this easier by using software or hiring a professional to look after your investments.
Take advantage of deductions
For real estate investors, there are a range of different tax deductions you can take advantage of. Some examples include certain property taxes, mortgage interest and even depreciation.
These deductions can add up to make a serious dent in your tax liability, so it’s well worth reading up on the different types you can use. Doing so can build a successful real estate portfolio while keeping your tax bill as low as possible.
Form an LLC
If you want to invest in multiple properties, creating a Limited Liability Company (LLC) may be more tax-efficient. This separate legal entity protects you personally from any liabilities to do with your investments.
LLCs offer tax benefits depending on your circumstances and give you more flexibility in deciding who decides on property maintenance.
LLCs are relatively easy to form and maintain compared to other business structures, but consult a lawyer to check you’re ticking all the boxes.
Hire a professional
Investing in real estate can be a big step. If you’re concerned about making the right choice for you, consulting with a professional who specializes in tax law will help you structure your investments in a way that minimizes your tax liability.
Are you ready to take the next step in your real estate investment journey? Click here to see how our specialists can help you keep as much of your hard-earned money with tax planning methods tailored to you.