It’s that time of year again when our anxious minds turn to wonder how much we’ll get back from the IRS or how much we’ll have to pay. But it doesn’t have to be a game of waiting and wondering. Business people, especially, need to be proactive and have a plan in place already in order to minimize payments by maximizing deductions and, as a result, maximizing profits. This is especially the case for real estate investors who often worry about cash flow. If that’s you, check out these 5 things Santa Cruz real estate investors need to know this tax season.
1. Depreciation Pays
The fact that investment properties can depreciate can be good news for Santa Cruz real estate investors. “Property owners have the ability to deduct depreciation value on their taxes. These annual tax deductions help real estate investors to recover the cost of income-producing rental property.”
Basically, you can use this depreciation deduction (as well as other deductions we’ll get to later) to offset the taxable income your properties generate. You can wind up either having a lower tax bill or deferring your tax liability till you sell the investment properties.
2. Interest – Not All Bad
Everyone hates paying interest, but it’s not all that bad at tax time. Real estate investors in Santa Cruz can deduct the interest paid on mortgage loans used to acquire investment properties.
You deduct the annual loan interest paid from your income to arrive at your taxable income, which means that interest can become your friend when you file. And if you are also able to take the depreciation deduction, you can significantly decrease your tax burden.
If you have questions about the best kinds of properties to allow you to take advantage of such deductions, your real estate agent can be a great resource. Call 831-588-2334 to find out more.
3. Re-Invested Profits Are More Profitable
A good way for Santa Cruz real estate investors to avoid paying taxes on profits is by re-investing those profits in other properties instead of simply pocketing them. Typically, this involves what is called a “1031 exchange.”
Here’s how the financial pros explain it: “According to the IRS section 1031, real estate investors can sell a property, to invest the proceeds in a new property and to defer all capital gains taxes. This allows investors to defer taxes by selling one investment property and using the equity to purchase another property or properties of equal or greater value.”
4. Changing Income Type Can Mean Lower Taxes
What do you call the kind of income you make? It matters for Santa Cruzreal estate investors more than you may think.
For the IRS and its purposes, there are only three types of income – earned income, investment income, and passive income. And the kind of income – the name you apply to the money you make – determines how you are taxed.
Earned income (the income you’d have from a job or self-employment) is taxed at the highest rate. The most common type of income for real estate investors is investment income, often mad by selling a property for more than it was purchased for. These capital gains are then taxed at the IRS-specified rate, but it’s less for properties held for at least a year.
Next is passive income, which is taxed at a higher rate, but that higher rate can be significantly offset to result in a lower tax bracket.”Passive income in real estate is income that is earned through residual cash-flowing properties such as a rental, REIT dividend, crowdfunding income, or private-equity income. Passive income is taxed at a rate similar to that of earned income, but there are deductions available to lower the net taxable income made from the real estate investment. The largest of these is called a pass-through entity . . . By changing the income you earn from ordinary income to investment income or passive income through real estate, you can lower your overall tax bracket.”
5. Business Deductions Are Your Friend
Now we come to the other deductions we mentioned alongside depreciation and interest deductions. There are, in fact, a host of business-related deductions that Santa Cruz real estate investors should take advantage of. They include deductions for:
- Property taxes and insurance
- Cost of property repairs (including capital improvements)
- Property-management fees
- Advertising and marketing expenses
- Fees for professional services
- Office expenses
- Travel expenses
- Education/training costs
- Professional association fees
No doubt, you’ll want to talk to an accountant or other tax/financial professional about pure tax matters. The other side of the investment tax coin, though, involves purchasing the right investment properties to maximize tax benefits. A local agent who specializes in these properties is the best ally Santa Cruz real estate investors can have.