Real estate investing has long been recognized as a reliable way to build and preserve wealth. It is, after all, the world’s biggest wealth builder. Beyond the potential for generating income and property appreciation, the U.S. tax code offers substantial incentives that can pass along significant tax benefits to real estate investors. Whether you are a seasoned investor or just starting, understanding these tax benefits is crucial to maximizing your returns and minimizing your tax burden.
This guide will explore the various tax benefits available to real estate investors, how you can leverage them to your advantage, and why platforms like mogul can make it easier to access these advantages, even with a modest investment.
The U.S. tax code is designed with specific incentives to encourage homeownership and real estate investment. These incentives are intended to promote economic stability, urban development, and personal financial growth. The tax benefits associated with real estate are not just limited to wealthy individuals or large corporations; they are accessible to any investor who owns rental properties, thanks to platforms like mogul that democratize access to real estate.
The IRS has designed the tax code to encourage two primary activities: procreation and homeownership. While mogul can’t assist with the former, it certainly plays a pivotal role in the latter by offering investors an opportunity to invest in real estate with little money and enjoy the full spectrum of tax benefits traditionally reserved for large-scale investors.
One of the most compelling reasons to invest in real estate is the array of tax deductions available to investment property owners. These deductions can significantly reduce your taxable income, enhancing your overall cash flow and making real estate an incredibly tax-efficient investment.
Here’s a detailed breakdown of the key deductions available to real estate investors:
The interest you pay on a mortgage is often one of the largest expenses for property owners. The IRS allows you to deduct this interest from your taxable income, significantly lowering your tax liability.
Costs related to the day-to-day management and maintenance of your property, such as repairs, utilities, and property management fees, are fully deductible. These deductions help reduce your taxable rental income, increasing your net earnings.
Property taxes are another significant expense that you can deduct from your income. This deduction reduces the amount of income subject to taxation, further enhancing your cash flow.
The cost of insuring your rental property is also deductible. This includes premiums paid for homeowners insurance, flood insurance, and any other types of property-related insurance.
Depreciation is one of the most powerful tax benefits available to real estate investors. It allows you to deduct the cost of the property itself over time, even though the property may be appreciating in value. This non-cash deduction reduces your taxable income without impacting your actual cash flow.
Minor repairs and maintenance work done on your rental property, such as fixing leaks or replacing broken fixtures, can be fully deducted in the year they are incurred. However, significant improvements—like adding a new roof or renovating a kitchen—are considered capital expenditures and must be depreciated over the property's useful life rather than deducted in the year of the expense.
If you travel to manage your rental property, you can deduct expenses such as airfare, lodging, and meals. This is particularly relevant for out-of-state or international property investors.
Fees paid to attorneys, accountants, property managers, and other professionals related to the management and operation of your rental property are deductible. These deductions can offset the cost of managing your investments.
Costs associated with advertising your rental property to prospective tenants can also be deducted. This includes online listings, print ads, and any other marketing efforts.
Even though a property value can appreciate over time, the IRS recognizes the wear-and-tear on an asset might devalue the structure of the property. As such, the IRS separates your purchase price into land and improvement. Land is just that, what your property sits on. Improvements mean improvements made to the land, so the structure and actual physical home sitting on top of the land.
The IRS permits investors to depreciate the value of the improvements (excluding the land) over a period of 27.5 years for residential properties and 39 years for commercial properties. This deduction is particularly advantageous because it reduces your taxable income without affecting your actual cash flow, making it a “ghost expense.” Typically, the property value is split 40% attributed to the land and 60% attributed to the improvements.
Let’s break down how depreciation benefits you as a real estate investor:
You purchase a residential property for $1 million, with an 80% loan-to-value (LTV) ratio. This means you have $200,000 in equity.
After deducting mortgage interest, operating expenses, insurance, and property taxes, your net rental income is 8% of your equity investment, or $16,000 per year.
The IRS allows you to depreciate 60% of the property’s value over 27.5 years. For a $1 million property, 60% equals $600,000, resulting in an annual depreciation deduction of $21,818.
In this scenario, you would report $16,000 in rental income on your tax return. However, you would also report $21,818 in depreciation, resulting in a $5,818 loss on paper. This “paper loss” can be used to offset other income, including income from other investments, thereby reducing your overall tax liability.
Unlike many traditional real estate investment platforms and Real Estate Investment Trusts (REITs), mogul is committed to passing along all the tax benefits of real estate ownership to our investors. Here’s how mogul does it:
When you invest with mogul, you’re purchasing a fraction of a property. Your share of the property’s income, expenses, and tax benefits is proportional to your ownership stake. This means that even if you invest a relatively small amount, such as $250 or $10,000, you still receive the full range of tax benefits associated with property ownership.
As a fractional owner, you receive a proportionate share of the depreciation benefits. For example, if you own 10% of a property, you would receive 10% of the annual depreciation deduction. This can significantly reduce your taxable income, just as it would if you owned the entire property. Because you are paid rental income in proportion to your investment, the depreciation is proportional to the rental income you receive, so it represents the full impact of the tax benefits to your investment. Put another way, if you own 10% of our example property above, you would receive 10% of the income ($1,600) and 10% of the depreciation ($2,181.8).
mogul coordinates the property management tasks, from tenant relations to maintenance. Similar to how a property manager would only reach out with significant operational decisions, if a repair or decision is below $1k, the property manager takes care of the repair or decision. If the repair or decision is above $1k, a governance vote is called, and you can vote between the options laid out in proportion to your ownership. Super majority decides, so even if one person owns a majority of a property, all owners have a say. .
mogul provides you with all the necessary tax documents, including K-1 forms, which detail your share of the property’s income, deductions, and depreciation. These documents are filled out and directly uploaded to your mogul account at year’s end, making it easy for you to file your taxes accurately and on time.
mogul’s platform is designed to simplify the entire investment process, from initial investment to tax reporting. Whether you’re investing with $250 or $10,000, mogul provides you with the tools and resources you need to manage your investments efficiently.
In addition to the deductions and depreciation outlined above, there are other tax strategies that real estate investors can utilize to further reduce their tax burden and maximize their returns:
A 1031 exchange allows you to defer paying capital gains taxes when you sell a property, provided you reinvest the proceeds into a property of “like-kind”. This can be a powerful tool for building wealth over time, as it allows you to continue growing your portfolio without the immediate tax impact. The key to a successful 1031 exchange is to reinvest in a property of equal or greater value within a specified time frame, ensuring you maintain the tax-deferral benefits.
Cost segregation is a tax strategy that involves breaking down the components of a property into different asset classes, each with its own depreciation schedule. By accelerating the depreciation on certain parts of the property, such as appliances, flooring, or roofing, you can reduce your taxable income even more than in straight-line depreciation by accelerating the depreciation. This strategy is particularly beneficial for investors with large properties or portfolios, as it can lead to substantial tax reductions in the early years of ownership.
Recent tax laws have introduced provisions that allow for bonus depreciation and the use of Section 179 to immediately deduct the cost of certain property improvements. Bonus depreciation allows you to deduct a large percentage of the cost of qualifying improvements in the year they are made, rather than spreading the deduction over several years. Section 179 works similarly but is typically used for smaller improvements or purchases, such as new appliances or office equipment.
Real estate investors can use passive losses (losses from rental properties) to offset passive income (income from other real estate investments or other passive income). If you are classified as a real estate professional, you may also be able to offset these losses against other types of income, such as wages or business income. The classification of a real estate professional comes with specific IRS requirements, but it can provide significant tax advantages if you qualify.
Under the Tax Cuts and Jobs Act, certain real estate investors may qualify for the Qualified Business Income (QBI) deduction, which allows you to deduct up to 20% of your qualified business income from rental properties. This deduction is subject to specific limitations and qualifications, but it can provide substantial tax savings for eligible investors.
The tax benefits of real estate investing play a crucial role in long-term wealth building. By reducing your taxable income and deferring taxes through strategies like depreciation and 1031 exchanges, you can keep more of your earnings invested, compounding your wealth over time.
Consider the impact of these tax benefits on a long-term real estate portfolio:
By deducting mortgage interest, operating expenses, and depreciation, you can significantly reduce your taxable income, increasing your cash flow. This additional cash flow can be reinvested into new properties, further expanding your portfolio.
Through strategies like a 1031 exchange, you can defer paying capital gains taxes, allowing you to reinvest your profits into new properties without the immediate tax burden. This deferral can continue indefinitely, enabling you to build a larger and more valuable portfolio over time.
Real estate investing is not just about generating income and building wealth—it’s also about taking full advantage of the tax benefits that come with property ownership. By understanding and leveraging these benefits, you can significantly enhance your returns and build a more profitable portfolio.
mogul’s online real estate investing platform is designed to pass along all the tax benefits of real estate, ensuring that you keep more of what you earn.
If you’re ready to start building wealth through real estate and take advantage of these powerful tax benefits, sign up with mogul today.