No one likes paying taxes, especially not real estate investors. Luckily, congress has been kind and offered a lot of tax breaks. Whenever you make a profit in real estate, there’s usually a way to avoid or atleast defer paying taxes.
The most well-known tax break is the 121 home owners exclusion. If you live in your property for 2 years[or 2 out of the past 5 years] you get to exclude 250k if you’re single and 500k if you’re married from your taxable income.
If you own investment real estate you cannot take advantage of this. Unless you move into it and live there for a full 5 years.
however, there are several ways to get around paying taxes on investment real
- Just pay the tax. long term is 15% fed and whatever your state tax is[max in CA is almost 10%]. If you already have several homes which you can depreciate and thereby create phantom losses, you can offset this passive gain through these passive losses.[You can deduct upto $25k of passive losses against regular income. If you have more, it gets carried forward until you have a passive gain to offset it against].
- Do a 1031 exchange to defer paying taxes on the sale.
- Put the proceeds from a sale into a Passive Annuity Trust.
- Buy and sell your property through a corporation. When you realize a profit, some of it can be expensed out and the rest can distrubuted as salary and used to fund a corporate 401k-pension plan [subject to approximately 15.5% tax]. This is good for short-term flips which would normally be clubbed with your regular income and subject to the maximum tax rate. The disadvantage with this is that you lose the ability to depreciate the losses against your regular income, although you can against corporate profits.[Atleast you do in a C-Corp. Not sure about S-Corp]
- Once you have money in your corporate 401k-pension plan, buy and sell property in it. This avoids taxation. This allows loses the ability to write off depreciation losses against regular income.
- Never sell the property. Just refinance it to pull out cash tax-free if you need it. When you eventually die, its passed on to your heirs at a stepped-up basis and they don’t pay taxes on it either!
- Invest the money in a working interest in an oil well. If set up as a real estate transaction you can do a 1031 exchange. Or they can be set up to give you a 90% write-off in the first year. [However, the deals that are set up to be tax advantageous have a higher premium, losing the benefit of not paying taxes].
Real Estate provides some of the best tax-advantageous investments available. Buy your investment real estate today!
These rules are neither complete nor may they pertain to your particular situation. Infact, they could be blatantly wrong or out-dated. Also, I’d like to stress i’m not a CPA so please consult your advisor before following any of my advice.