It's not how much you make, it's how much you keep that counts!
Warren Buffet
Real Estate investing offers extraordinary tax advantages not available with other types of investments. If properly structured, your investment may have little or no taxable income until you sell. Additionally, there are several opportunities to defer the gains. Below are some highlights of certain tax advantages available to real estate investors.
Basic Deductions | Depreciation | Write-offs | Loss Carry Forward | As Professional | 1031 Exchange
Basic Deductions:
Nearly all expenses associated with the purchase, sale and management of the property are tax deductible. Some common deductions related to real property include: closing costs, mortgage interest, travel expenses, repairs & maintenance, property taxes, homeowners association fees, advertising, insurance, supplies, management fees, and utilities.
Depreciation:
With Real Estate, you are allowed to "depreciate" the value of any "non-land" (aka the "building") portion of the asset. In the US, the building is depreciated evenly over 27.5 years. This deduction costs the investor NO CASH and offsets most (if not all) of the rental income generated from the property. Depreciation can often exceed the amount of income generated and allows the investor to show a loss on the investment, even while it generates positive cash flow.
For example, a home is valued at $200,000, and $150,000 of the value is related to the structure. The annual depreciation is $5,455 ($150,000 / 27.5). If the home cash flows $200 a month for an annual positive cash flow of $2,400, the investor will pocket the $2,400 cash and still claim a loss on the investment of $3,055 ($5455 - $2,400).
Rental Write-offs:
Rental real estate is typically considered "passive activity" and losses from passive activitiy can only offset income from other passive activities (meaning a part time investor cannot use real estate losses to offset "regular" income). But there is an exception:
When the investor actively participates in basic management decisions, up to $25,000 of losses, including depreciation, can be taken to offset income from salaries or other investments. Active participation is satisfied without substantial involvement and while using a property management company.
Loss Carry Forward:
Since passive losses can only be used to offset passive gains, you cannot typically use 100% of your losses on real estate in the current year. However, these losses CAN be cumulatively CARRIED FORWARD to offset the gain on the sale of your real estate investments.
Using the depreciation example above (see Depreciation), the $3,055 loss will be carried-forward to offset the gain on the sale of your property.
Real Estate Professional Status:
If the investor spends most of his/her time in the real property businesses, he/she is considered a real estate "professional". Professional status allows an investor to deduct all losses in the current year to offset any other income. That includes income from his employment, or earned by a spouse. Using the depreciation example above, the $3,055 loss will be used offset other income earned by the investor in the current year. The Real Estate Professional requirement is satisfied if the investor or spouse spends 750 hours or more in the real property business.
1031 Exchange (Like-Kind Exchange):
A 1031 exchange offers investors the opportunity to defer taxes on real estate gains by reinvesting the gains in similar real estate investments. When a property is sold through a 1031 exchange, the investor can claim ZERO gains if the proceeds are re-invested within 6 months. This is a powerful tool for the serious long-term real estate investor, as it can produce significant tax deferrals and savings.
NOTE: Although the CRA does not recognize 1031 exchanges, there may be ways to structure your Real Estate investments in order to capture it.
