Tax deductions for real estate investors

Ginger Dean

March 27, 2014

By: Ginger Dean, Home Finance Specialist

In: Finance and Legal

Real estate investors buy and sell homes for profit. The IRS determines real estate investor status for tax payers based on several criteria, including how many properties you sell per year, how long you hold properties, and if you collect rental income in addition to flipping homes.

Real estate investors have several tax advantages that can help them save on their tax bills. These range from deferring capital gains to setting up quarterly tax installments. If you are buying and selling real estate, it's important to speak with an accountant to take full advantage of all available tax deductions. Be sure to ask about the following:

Deferring capital gains. One major tax advantage for real estate investors is the option to defer capital gains from the profit of the sale of their real estate properties. If real estate investors hold their properties more than a year, they receive a lower capital gains tax rate. Real estate investors can also defer capital gains indefinitely year after year. All you have to do is file a 1031 like-kind exchange when you sell a property.

Separating flipping from renting. If you flip houses as well as rent properties - be careful. The IRS has two types of classifications when it comes to income from real estate: investor and dealer. It's important to be classified as an investor whenever possible because there are definitely more tax advantages.

If you earn your primary income from flipping houses and renting houses than the IRS will consider you to be a dealer and you don't want that. Avoid paying higher taxes by keeping your real estate rental business separate from your flipping business. Keeping your businesses separate also gives real estate investors asset protection benefits. If one corporation is sued, properties within the second corporation will be protected.

Set up tax installments. Real estate investors can set up quarterly tax installments, whereas real estate dealers cannot. The advantage of having quarterly tax installments is investors only pay taxes on their profits as they receive them throughout the year. There is no need to pay a lump sum tax bill due to capital gains from the sale of a property. It's a lot easier to manage your income and expenses if you can plan ahead and you don't have to shell out a huge chunk of cash at one time.

Consider holding properties in your retirement account. If you hold properties in a retirement account such as a 401(k), a self-directed IRA, an SEP IRA, or a SIMPLE IRA you are not required to pay income tax or capital gains tax on any profits. This rule applies as long as the money always remains in your retirement account.

Knowing exactly how you'll be taxed can help you plan your monthly budget - not to mention help ensure you won't be floored by your tax bill.



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