When you’re investing in real estate, you need to think about capital gains–something you don’t consider with your residential home. Savvy real estate investors understand the importance of real estate tax shelters, which lower their tax obligations. Here are the three best tax shelters you need to know as a real estate flipper.
1. 1031 Exchange
A 1031 exchange, which is also called a like-kind exchange, allows you to trade in one investment property for a new one. In order for assets to be considered like-kind, they must be “the same nature or character, even if they differ in grade or quality”. For instance, if you sell a single-family home that you flipped, you can buy another home with the intention to flip it and defer any capital gains that would otherwise be owed when selling an investment property, but you could not use this principle to sell a single-family home and purchase a condo because the assets are not considered like-kind.
In most cases there’s no tax with a 1031 exchange; however, some sellers may owe a limited tax. With 1031, you must buy an investment property; you can’t flip a home and then buy a new residential property. Additionally, the market value of your new property must equal or exceed the value of the old property.
If you are interested in doing a 1031 exchange, you will need to act fast. Legally you must buy a new investment property within 180 days of closing on your flipped home; however, you must first identify three potential properties within 45 days of the closing. These timeframe constraints must be followed if you want the real estate tax shelter benefits, so take note and start browsing listings accordingly.
If you’re new to the world of real estate investment, this strategy is likely not for you. Successfully implementing a 1031 exchange is highly complicated. If you do decide to go this route, you will need to find a qualified intermediary to hold on to capital gains while the sale is pending; similar to an escrow account an agent in a traditional home purchasing transaction.
As an investment property owner, you may already be familiar with depreciation. This is commonly used for rental properties and to deduct property wear and tear, for instance on taxes.
To lower your tax obligation as a real estate investor, you can use tax deductions to account for property repairs. You can depreciate the building, together with any property improvements.
Depreciation delivers a small number of tax deductions over the lifetime of an asset. Since it spreads out the deduction over 15 to 20 years, on average, you won’t notice huge savings in any given year. However, it’s a nice tool to lower the tax obligations of rental property, so it’s one of the tax benefits of real estate investing worth remembering.
3. Mortgage interest
If you carry a mortgage on your rental property, you can deduct mortgage interest paid come tax time. There won’t always be significant real estate investment tax shelter benefits when you are flipping a house, because odds are you sell the property within a year of purchasing, but every little bit helps.
Get a CPA
Navigating tax codes is a difficult job, and owning investment property comes with enough responsibilities. Rather than worry about finances, hire a CPA who can make sure you are up to date and identify any potential tax benefits you may not have fully leveraged. With the time saved on accounting, you can spend more time building your real estate empire, whether you’re a frequent flipper or rent to tenants.
With any investment vehicle, you must keep your eye out for ways to boost profit. One of the surest ways to boost your profit with real estate investments is to use all eligible real estate tax shelters to lower your expenses.
Get a lending partner
Are you looking for funding for your next investment property? Sherman Bridge approves quickly, with many deals funded and closed in as little as seven days. We fund up to 90 percent of the investment and keep our rates low, so you can find and buy your next investment home while meeting any deadlines, such as those mandated for a 1031 exchange.