Everyone knows that planning for retirement and investing go hand-in-hand. However, as I’ve written previously, smart planning also considers both the current and long-term tax implications of your investment decisions. 

We often talk about 401(k) and Roth IRA tax strategies (and these are great strategies) — however, we must be careful not to overlook the long-term investment prospects and tax benefits associated with real estate investing. 

Real estate investing not only offers the potential for appreciation, regular income through rent, and the ability to multiply gains through financial leverage, but of course, it also offers compelling tax benefits!

First, a few caveats about real estate investing

Real estate investing is not necessarily easy, and economic returns are never a sure thing. Also, navigating the intricacies of tax codes and regulations can be intimidating, especially when you’re first getting started. However, compared to most other tax strategies, the majority of the tax benefits associated with real estate investing are not overwhelmingly complex. 

While I always recommend you seek individual professional advice, I’ll outline a few of the basic real estate investing tax benefits here in the hope that you can use them to maximize your returns. 

Tax benefits of real estate investing

1. Real estate depreciation

As you may have heard, depreciation is a significant tax benefit for real estate investors. But how does depreciation work exactly? 

The IRS acknowledges that properties degrade over time and allows investors to deduct a portion of the cost of the property over its “useful life.” For real estate investors, these deductions can really add up. 

This might seem obvious, but consider the implications and the benefits. 

Primarily, consider the fact that depreciation is a non-cash deduction. This means that you can use the deduction to offset cash income, effectively resulting in tax-free cash income. This is almost as good as it gets in the world of tax benefits. 

The deduction becomes even more compelling when you consider that there is no parallel for it in stock market investments. With those investments, you must wait until you sell the investment to take a deduction for the investment cost. 

While it is true that maximizing depreciation can be a complex process, the basic concept and the general deduction are not complicated, and you can use this strategy to significantly increase your return on investment. 

2. Real estate capital gains tax treatment

Our current tax code is designed not only to fund our national government but also to incentivize behavior. For example, the government wants to encourage long-term investing and has created a system that allows long-term investors to pay less tax! 

For real estate investing, understanding this two pronged approach can pay real dividends, especially when it comes to gains on the sale of your investment. 

Again, this is not complicated. The profit from selling a property at a higher price than you paid for it is considered capital gains, and if you hold the property for more than a year, these gains are generally either not taxed or taxed at lower long-term capital gains rates. This tax benefit is known as the “Long-Term Capital Gains Tax Benefit.” 

Although this benefit is also available for other types of investments (for example, the stock market), this is considerably different than the tax consequences of a 401(k) investment, for example. While all gains on a 401(k) investment are deferred until retirement, the tax rate at retirement is the higher ordinary income tax rate — no matter how long you held those investments.

Best of all, real estate is a natural fit for the long-term capital gains tax benefit, especially if you intend to hold the property and rent it out for a number of years.

3. Business tax deductions for owners of real estate

Owning rental real estate is not only an investment but also a business. This seems obvious, but this concept has real tax-saving implications. 

Specifically, because your investment is also a business, you are allowed to deduct ordinary and necessary business expenses associated with your real estatement investment. This means that lots of expenses you might otherwise pay anyway are now tax deductions! 

For example, because you need a cell phone to manage your real estate investment, you are entitled to a tax deduction for a portion of the expenses associated with your cell phone — it is an ordinary and necessary business expense. 

While there are hundreds of other expenses real estate investors can validly deduct, property taxes and mortgage insurance are the most obvious. These business deductions add up and can result in big tax savings for real estate investors. This is especially compelling because there is no similar concept or deductions available with stock market and 401(k) investing. 

Conclusion:

The tax advantages of real estate investing are plentiful and can significantly enhance the profitability of your investments, helping you meet your retirement savings goals. 

As with all things related to money, investing, and tax, it is critical to keep good records. Quicken is a great way to keep all of your records clean and organized. 

This is especially important when it comes to real estate investing because the extra deductions available to those who keep good records are truly compelling. 

As always, I recommend professional advise and assistance because tax laws are complex and frequently change. However, many of the overall tax benefits are obvious and easily accessible to all, so do not be afraid to ask questions and take the next step. 

Remember, every investor’s situation is different, so the benefits you enjoy may vary. Nonetheless, understanding the tax benefits associated with real estate investing is an essential first step toward maximizing your investment returns and reaching your retirement goals through real estate investing.