The tax benefits of real estate investing make it one of the best ways to build wealth. As I have said many times, whenever you are figuring your returns on real estate, you must include the tax benefits. A lot of people fail to do this. I had people recently tell me they paid $120,000 in taxes in the first quarter alone! I thought about all the real estate we could have bought with that much money, and how we could have sheltered those taxes.
Tax Benefits 101
Let’s start with the basics. Depreciation allows you to deduct approximately 1/27th of the value of your property, not counting the land, from your taxes. The loss from depreciation goes directly against any kind of profit or gains that you had on the property. You can also deduct any interest that you are paying on the home loan. Income and loss are divided into passive and earned classifications and are taxed differently.
Did you know that passive income (rents for example) is taxed at a much lower rate than earned income? That means you get to keep more of the profits earned from investments than you do from your paycheck. As far as tax-advantaged investments go, real estate is one of the best. In fact, you can actually earn tax-free income using a number of different real estate investing strategies.
How to Qualify
The Real Estate Professional tax designation is one of those strategies. Beginner real estate investors should work toward this designation. Basically, it says that if you spend 750 hours a year (about 15 hours a week) on your real estate investments and you own your real estate business, then you can receive the full benefit of your tax exemptions. Currently, the IRS will limit your deductions to $25,000 annually if you do not have this designation. If you make $100,000 or more, it will disappear at $150,000. In other words, if you have $150,000 of taxable income, you will not receive your full real estate deductions unless you have this designation.
As you begin to build your real estate business, keep this in mind. If you combine “buying and holding” with “buying and flipping” or “wholesaling,” then this designation will become easier to get. The designation is not something you apply for but is a check box on your tax return. The IRS doesn’t make it easy to qualify for, but the REP designation makes a significant difference in the tax benefits of real estate investing. You can be making a net PROFIT on your rentals, AND wash away the tax liability from your job salary, business, or 1099 income!
I have a student who purchased a six-unit building and because he was always looking for bargain deals and did not have the cash to buy the properties, he would raise cash by wholesaling to other investors. His wholesaling business grew, and in his first year of investing, he could claim the real estate professional tax designation. I highly recommend you make this designation a priority.
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It Can Be Done
Bill Bronchick, an attorney who specializes in real estate, is frequently a speaker at WealthBuilders events. He will tell you the extra effort to gain the Real Estate Professional tax designation is well worth the time and energy. It allows you to use real estate losses from passive income to offset taxes on earned income. Without the REP designation, you can only apply passive losses to passive income. Even though you can roll the passive losses into the following year, the benefits remain marginal without the Real Estate Professional tax designation.
If you work a full-time job not directly related to real estate, gaining the REP designation becomes more difficult. Because the requirements are not just the 750 hours, but also that your rental activity is 50% of what you do during the year, which is not possible if you are a full-time attorney or nurse, etc. If your spouse does not have a full-time job, Bill Bronchick recommends they get a real estate related position which will verify to the IRS your 750 hours and 50% activity.
The options for real estate related work are not limited to being a real estate agent, but can include construction, reconstruction, acquisition, rental, operation, management, leasing and brokerage. Be aware that these activities are working, not investing. The catch-all is: based on the facts and circumstances, you participated in the activity on a regular, continuous and substantial basis during the year.
This is just one strategy to help you take advantage of the tax benefits of real estate investing. At WealthBuilders we have abundant resources to either help you get started or take you to the next level of investing. Take some time to find the resources you need that will fit your investing and life plan.
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While it’s true that 90% of the world’s millionaires built their wealth by investing in real estate, most of them weren’t rich when they got started. Contrary to popular belief, you can start from humble beginnings and invest in real estate. Get a mentor in the field, learn all you can from resources available, keep good records—not only of your expenses, but of your time spent—and seek the Lord for the wisdom and the courage to step into a journey of building wealth for the Kingdom.
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