Tax Breaks for Buy-and-Hold Investors: Part 1
November 8, 2017
Whether flipping properties for short-term cash or holding on to long-term investments, the IRS has historically been a friend to real estate investors in terms of tax breaks. However, some of the most powerful tax benefits available to investors are reserved for long-term investment strategies; beyond this, several benefits also available for short-term buy and sells are far more effective for the long-term investor. Below, we'll provide a brief summary of some of the most important tax strategies for making or supplementing a living from real property.
Note: Two of the most powerful tax breaks for real estate investors are 1. the 1031 exchange, and 2. Depreciation expense. These allowances, while formidable, are far more complex than the tools we'll discuss below, and will warrant their own topics in future posts. With that said:
1. Ordinary Deductions
With a few exceptions, the vast majority of rental expenses are deductible-- it's vital to keep track of every cent that goes into your investment. While we explore this at length in other posts, buy-and-hold investors should pay particular attention to deductions ordinarily not applicable to short term transactions; this ranges from property management fees (whether to a manager or the investor), maintenance costs, and utilities to postage, insurance, and tenant turnover.
2. Special Deductions
While not applicable to all investors, numerous additional deductions are available to investors managing their own properties. The home office deduction is a stellar one; besides the cost of ordinary office expenses like computers, printer, internet, phone, etc., landlords can frequently include other home expenses under this deduction such as mortgage interest or maintenance costs. This deduction is, unfortunately, adjusted based on the size of your office in relation to the rest of the home-- however, investors with a sizable office and/or large home expenses can reap some serious savings.
A similar deduction is available for meals, travel, and mileage for investors on the road managing or transacting properties.
3. Capital Gains: Long vs. Short Term
With a few particular exceptions, the sale of a property will almost always be taxed. However, what many new investors do not realize is that the IRS treats the proceeds of this sale quite differently for a long-term investor.
"Flipping" a property typically results in short term capital gains treatment, unless the owner has held the property for over a year. "Short term capital gains" is a bit of a misnomer, as, unlike the more favorable long term treatment, short term sales are typically taxed in the seller's normal tax bracket.
Buy-and-hold investors, however, often receive much better terms. For properties held longer than one year, long term capital gains treatment means sale proceeds will normally be taxed at separately prescribed amounts: 0%, 15%, or 20%, depending on the filer's income bracket. More information can be acquired on the IRS website, but for example purposes, a married couple filing jointly with a taxable income of $74,900 or less would likely pay 0% in capital gains taxes (far better than the 15% they would likely otherwise pay upon a short-term sale). Beyond this, a 15% tax rate is incurred on a long-term property sale for the same couple with a taxable income of up to $464,850; for comparison, filers at the upper end of that bracket are likely paying 28-35% in ordinary income tax. For earners above this amount, long term capital gains are capped at 20%, still phenomenal saving compared to a short-term sale taxed at the ordinary amount.
As you can see, capital gains can make an astounding difference for a buy-and-hold investor.
As we've seen thus far, there are a wealth of tax breaks available to long-term investors. In Part 2, we'll cover tax-free refinancing and Self-Employment taxes. In the meantime, if you'd like to know more about maximizing the tax treatment of your investments, contact us at JSB Tax Services.