Investing in real estate is a great way to diversify away from the uncertainty and lack of trust that many investors feel towards the stock market. When you own real estate for investment purposes, you know exactly what you have, and there's an inherent value in real estate that doesn't always exist with stocks. In fact, real estate has many tax advantages that simply aren't available for other kinds of investing.
As with the mortgage on your primary residence, interest on loans that you take out to buy investment real estate is generally deductible. The value of this deduction can be even greater than what you're used to getting with the deduction for your primary residence because the interest you pay to borrow money for investment properties is likely to be greater than for your personal mortgage, and because the business deduction doesn't phase out because of Alternative Minimum Tax (AMT) rules.
Maintenance and Upkeep.
Virtually every expense you incur to maintain and improve your investment real estate will help reduce your annual tax bill. Some expenses, such as HOA or condo fees, carpet cleaning and lawn care will be immediately deductible in the year in which they are incurred. Other types of expenses, such as purchasing replacement appliances for a residential rental property, will be considered capital improvements and can be depreciated over time to reduce your tax bill for your rental investments.
When you buy real estate for investment purposes, the improvements on that property are considered to be capital asset that you can depreciate as you would with other investment assets. For real estate, the depreciation term is generally 27.5 years. This means that every year you can deduct 1/27.5th (approximately 3.6%) of your basis in the property. So if you have a $100,000 basis in a new investment property, you'll have a $3,600 deduction each year as a depreciation expense. In many cases, this will offset much of the rental income you receive on the property for tax purposes. Taken together with any other property related expenses you have, you may have a minimal tax liability each year for the property, even as you collect rental income. But note that taking this depreciation reduces the basis in your property correspondingly, so if you decide to sell the property you could face a large capital gains liability.
Section 1031 Exchanges
Fortunately, there are ways to move in and out of individual properties without incurring an immediate capital gains tax liability. Section 1031 of the tax code provides that certain types of business and investment properties can be exchanged for "like kind" properties without incurring an immediate tax hit.
These tax tips are intended as general guidance, so you should consult with your tax advisor to verify how they apply to your particular real estate investment.
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Article Added on Monday, May 19, 2014
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