Investing in real estate is one of the ways to earn an income. You can decide to have this as a side hustle or the primary income. However, you are eligible for high taxes. These taxes can limit your income. You want to maximize your revenue; therefore, you’ll look for legal ways to evade them. Transferring your money overseas or burring under your mattress is risky; neither are they legal options here. Therefore, you need to consider the below options to reduce taxes on your real estate investment.
Buy Real Estate Under Trust
Buying property under a trust is an ideal way to avoid high taxes. It means that the trust would take over the ownership of the property. There are other benefits associated with trust compared to the conventional way. Also, rather than becoming the outright owner, you can become the trustee. Therefore, after you pass away, a designated individual or institution would take over the ownership of the property.
However, your main aim is to enjoy the reduced taxes associated with trust purchases. It is recommended that you review the option you have before you purchase the property. You can decide to opt for the revocable or the irrevocable trust. With a revocable trust, you have complete control and can make changes whenever you please. With an irrevocable trust, you are not allowed to make changes without permission from the beneficiaries. Before you initiate a trust purchase, ensure that you have your lawyer and financial advisor to help you navigate through the laws. Plan a meeting with both at the same time to avoid misinterpretation or any differences.
Hold Property for More Than a Year
You’ll be taxed at a regular income rate when you buy a property and sell it for a profit in less than a year. Such a tax is standard for those who buy anything and resell the property at a profit. It becomes worse when you flip more than one property in the same year. Here, you’ll be subjected to double FICA taxes. The IRS would classify you as a dealer.
An ideal way to avoid such taxes is when you hold the property for more than a year. You’ll no longer be classified as a dealer. You’ll be taxed on capital gains rather than FICA taxes. Taxes on capital gains are significantly lower than ordinary income taxes.
Holding the property for more than a year can be challenging, considering you are in a real estate business. However, you can consider renting the property before you sell it. Besides lowering the tax rate, you’ll be earning more through rent. Also, you can consider living in the house during this time. You can make upgrades and improvements, increasing the value of the home. If you live in the house for the first two years, you won’t be taxed for the first $250,000 of the capital gain when you are single. It would be even more convenient when you are married, as the first $500,000 capital gain would be tax-free.
Take Advantage of Business Deductions
Business investors have access to many tax deductions yet more don’t take advantage of these. Real estate investment is no exception. Some standard tax deductions include property management fees, repairs and improvements, professional fees, travel, marketing, advertising expenses, property taxes, mortgage interest, and insurance premiums. From the above list, there are significant deductions that will reduce the tax placed on the property. Speaking to an accountant will help you identify the gray areas.
Utilize 1031 Exchange
Section 1031 of the tax code states that you can defer paying taxes when using the profits to buy a similar item. Therefore, the amount you use to buy a property can be used back to buy another. You can use it as a down payment for another property, maybe a unit rental. You can then earn monthly cash flow. You can decide to sell the following property or do another 1031 exchange. However, when you sell the property, you’ll need to pay taxes on the profit. Though, you don’t need to sell, as you can enjoy an unlimited flow of rental income when you buy a rental property. Also, it gives you the motivation to invest in higher-priced real estate earning more revenue through rent.