Understanding the Tax Benefits of Real Estate Investing: An Introduction

In another post on the Midloch blog, we elaborate on the various reasons people invest in private real estate — including to diversify from stocks and bonds into uncorrelated assets, as a hedge against inflation, and as a source of income. There are more reasons real estate is popular as an alternative investment, including the tax benefits.

 

The full extent of the benefits depends on your individual situation and sources of income. As Jesse Halstrom, CPA, says, “Investing in real estate is easier than ever before. However, enjoying the tax benefits of real estate investment can be more complicated.” Jesse is founder and CEO of Rooted Tax Group, which provides real estate tax, planning, and advisory services.

 

When considering the tax consequences of investing in private real estate, understanding these benefits is a good place to start:

●      Depreciation deductions. Depreciation deductions from investing in real estate can reduce taxable income from real estate investing.

 

What is depreciation? It’s the wear and tear, deterioration, and obsolescence that buildings experience over time.

 

Depreciation is a non-cash loss. You can take depreciation deductions even though no cash was lost. Deductions are generally taken in equal amounts over the life of a property, according to the U.S. Internal Revenue Service, and can reduce taxable income from real estate investing and, by virtue, boost returns.

 

Some investments qualify for accelerated or bonus depreciation deductions that allow investors to depreciate property faster or in larger increments; in other words, take bigger deductions.

 

●      Losses from real estate investing. If there are cash losses from private real estate investing, a passive investor can use them to reduce taxable income from real estate investing and, over time, income from non-real-estate investing activities.

 

The whole matter of losses and gains and which deductions can be taken against which types of income and when is a somewhat complex issue. A real estate tax accountant or investment advisor can be helpful to understand how you can fully benefit under the tax code.

 

●      Capital gains tax rate. Gains from the sale of investment properties that are held for more than a year are taxable at the capital gains rate, which is typically lower than the ordinary income tax rate at the federal level (depending on your situation) and in many states. You experience a capital gain on a property sale when there is appreciation above the purchase price. Appreciation, of course, is typically a primary goal of real estate investing.

 

●      Inheritance benefit. If you die while holding an investment in income property, your heirs will get a step up in basis when you pass the investment to them. So any gains that accrue to your heirs would be based on the value of the investment at the time of inheritance, which would minimize their tax bill.

 

 

The U.S. tax code encourages and rewards prudent investment in commercial and multifamily real estate. The availability of the tax benefits and the full extent you could benefit from them depends on your individual situation. Consult a real estate tax expert like Jesse Halstrom for more information.