Real estate is among investors' most tax-efficient asset classes since capital gains are usually not triggered until you sell the property. However, that doesn’t mean you can’t avoid taxes on real estate investment if you plan.
Although taxes are rarely triggered upfront when investing in real estate as an individual, these transactions still involve costs and liabilities that must be considered from a tax standpoint. An informed investor understands how taxes factor into investing in real estate and takes measures to reduce potential liability.
In this article, we’ll give details on how to avoid taxes as an investor in real estate by taking several key steps. By consulting with knowledgeable Real estate investor taxes Stone Mountain advisors, structuring your investments correctly, and keeping meticulous records throughout your real estate portfolio life, you can significantly reduce your potential tax liability while also protecting yourself against potential risks.
Ways To Avoid Investor Taxes In Real Estate
Here we have compiled some ways that can assist you in avoiding taxes as an investor in real estate.
- Organize your tax strategies before you invest
- Separate your investments to avoid taxes on real estate
- Defers Taxes With Real Estate Investment Trusts (REITs)
- Diversify to defer taxes by investing in mutual funds
- Diversify and hold for the long term to benefit from depreciation
Organize Your Tax Strategies Before You Invest
Tax strategies are a must for any investor investing in real estate. Whether you're buying or selling, taxes can significantly impact your bottom line. But there are ways to minimize the impact.
For starters, research each investment option's tax implications before making an investment decision. Then, ensure you're organized and prepared to handle any potential tax issues as they arise.
Finally, keep accurate records and track your investments to know precisely how much you've made and where your money has gone. By taking these steps, you can avoid unnecessary tax headaches and keep more of your hard-earned money in your pocket.
Separate Your Investments To Avoid Taxes On Real Estate
You can use the same strategy with stocks and real estate. You need two accounts for your real estate holdings: one for long-term investments and another for short-term investments, such as cash.
- Short-term investments are taxable.
- Long-term investments are not.
This can be a great way to save taxes on your real estate investment without having to sell off your actual property. It’s also an excellent way to diversify your portfolio.
Some investors, however, do not like this approach because it can be time-consuming and tedious to manage two separate portfolios, especially if you have multiple properties across several states.
You will also want to ensure no overlap between the two portfolios. If you buy a second property in the same state as your first property, then you will want to contribute the same amount of money from each property into your long-term account; otherwise, you will be taxed twice on the same property.
Defers Taxes With Real Estate Investment Trusts (REITs)
REITs are a popular way for investors to defer taxes. REITs allow you to pass gains from real estate investment properties to others without triggering a taxable event. In effect, REITs allow you to earn income without paying taxes on the income. This can be a valuable strategy for long-term investors who want to defer taxes on future capital gains.
There are two types of REITs: taxable and tax-free.
- Taxable REITs are designed to help investors pay taxes when they sell their property.
- Tax-free REITs, also known as "pass-through" REITs, allow investors to defer taxes on their investment income by reinvesting it in more properties.
However, these investments have lower returns than taxable REITs and may be illiquid, making it difficult to sell your investment if you need money in the future.
Diversify To Defer Taxes By Investing In Mutual Funds
Real estate investment is a great way to diversify your portfolio and defer taxes. But there are many risks that come with owning a property. Investors can avoid these risks by investing in mutual funds instead of real estate. Mutual funds offer several benefits to investors, including,
Diversification
Mutual funds offer a variety of investments that allow investors to spread their money across different sectors, industries, and geographical locations.
Easier access
Mutual funds are available for purchase through most financial institutions and brokerage firms, making them more accessible than real estate investments.
Lower risk
Unlike the volatile nature of the stock market, mutual funds have low volatility, making them less risky for investors.
Tax Deferral
Unlike real estate investments, mutual fund dividends are not taxed in the year of receipt.
Portfolio Privacy
A single individual or company does not own mutual funds, and mutual fund holdings are not publicly available.
For example, investing in a mutual fund can be safer than investing in real estate by avoiding risks such as rising interest rates and inflation.
Summing Up
There are other ways too in which an investor can avoid taxes while investing in real estate.
The first way is to buy property in a low-tax state and rent it out to someone else. The second way is to purchase a property that has already been depreciated by the IRS and rent it out. The third way is to use Section 1031 of the Internal Revenue Code, which allows for exchanging properties without paying capital gains tax on any profit made from selling one property to purchase another.
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