Tax tips before investing in real estate
Real estate has become a very appealing investment option. Despite occasional trauma, it’s an investment that doesn’t decay and destroy, instead will become more valuable as time goes. The right type of real estate is always a good investment option. Real estate investments in Naperville come with tax returns and one needs to understand how to handle tax on the real estate investments, maximize tax returns and ensure that you don’t get in to tax issues.
Following tax tips have been put together by the tax experts around the country. However, the tax discipline in the United State is always changing, therefore you need to verify with your tax advisor before using them on your taxable real estate investments.
- Do not include initial repairs and capital improvements as an immediate tax deduction. Repairs to fix the damages, restorations are part of capital, therefore not deductible. The best option is to claim depreciation on such expenses since capital works deduction over a period of 40 years.
- If you wish to claim tax benefits involved with owning a real estate, you need to be actively engaged in the management of the property. According to IRS, active involvement means deciding and approval of rental, collection of rent and involvement in capital improvements.
- Almost all expense incurred in repairing, maintaining and improving the property is deductable. Therefore, you need to keep records of every deductable expense. During an audit, the IRS will require documents (e.g. bills, receipts, etc…) as evidence for deductable expenses.
- Profits from the sale of a real estate property is considered capital gain, rather than income and taxed accordingly. However, you are entitled to more tax deductions through deferred taxation. i.e. the cash flow from one real estate sale can be directed to purchase the next property, without paying tax on the first sale.
- When the ownership of a real estate property changes, the depreciation cycle starts again. i.e., when you buy a rental property, whether the property is 2 years old or 50 years old at the time of the purchase, doesn’t make a difference. The IRS considers the economic life span of a rental property to be 27.5 years since the date that the title is passed to the new owner.
- Short term capital gains (assets which are held for less than a year) are taxed at the same rate as the general income. Therefore pay attention to the holding time before reselling a property for quick-turnover. For example, selling a property within 10-11 months of purchase can result in a significant loss with respect to tax deduction. In order to receive long-term capital gain tax reductions, hold a property for at least 12 months before reselling.
- IRS recognizes those who trade multiple properties within a period of a year as ‘dealers’. Dealers are not entitled for capital gain tax deductions because their profits on buying & selling real estate is considered as ordinary income. In addition to that, dealers can’t depreciate properties, and the rent on the property they hold are considered as income. Therefore, if you wish to buy and sell multiple properties within a year, you need to do so in different names such as under separate corporations.
- Capital Cost Allowance (CCA) is an effective method to protect the real estate income from taxes. This can be done by transferring part of the tax obligation to future tax years. It is done by amortizing a part of the rental property cost against the rental income.
- Find yourself a good accountant. It is often helpful to find an accountant who is also a real estate investor. A local real estate investment group can help you find the best accountant to make sure you maintain a clean tax file for your real estate investment.