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Real Estate Investor Tax Guide

Introduction

Real estate investing offers significant tax advantages, but without proper planning, investors may miss out on valuable deductions and strategies. This guide will help real estate investors understand how to minimize taxes, maximize deductions, and structure their investments for the best financial outcomes.

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1. Choosing the Right Business Structure

 

How you structure your real estate investments impacts taxation, liability, and long-term profitability.

 

Sole Proprietorship

  • If you own rental properties in your name, rental income is reported on Schedule E.

  • No legal protection from lawsuits or liabilities.

 

Limited Liability Company (LLC)

  • Provides legal liability protection while maintaining pass-through taxation.

  • Can be taxed as a disregarded entity, partnership, or S Corporation.

 

S Corporation (S Corp)

  • Not ideal for long-term rentals, but may be useful for real estate professionals or those flipping properties.

  • Allows owners to pay themselves a reasonable salary and take distributions to reduce self-employment tax.

 

C Corporation (C Corp)

  • Best suited for large-scale real estate businesses, but double taxation is a concern.

  • Allows for reinvesting profits at corporate tax rates.

 

2. Rental Income and Deductible Expenses

 

Taxation of Rental Income

  • Rental income is taxable in the year received.

  • Security deposits may be considered taxable income depending on lease terms.

 

Common Deductions for Rental Properties

  • Mortgage Interest – Deductible for rental properties.

  • Property Taxes – Fully deductible.

  • Depreciation – A non-cash deduction that spreads the cost of the property over 27.5 years (residential) or 39 years (commercial).

  • Repairs & Maintenance – Costs for keeping the property in good condition.

  • Property Management Fees – Deductible if you hire a property manager.

  • Travel & Mileage – If related to property management.

  • Legal & Professional Fees – Including CPA, attorney, and consulting fees.

 

3. Depreciation and Cost Segregation

 

Standard Depreciation

Depreciation allows you to deduct the cost of your rental property over time, reducing taxable income without affecting cash flow.

 

Cost Segregation

  • Accelerates depreciation on certain components (HVAC, flooring, appliances) to deduct more in earlier years.

  • Typically used for commercial properties or high-value residential properties.

 

4. Real Estate Professional Tax Status (REPS)

  • If you spend 750+ hours per year materially participating in real estate and it’s more than half of your working hours, you may qualify.

  • Allows rental losses to offset other income without passive activity limitations.

  • Documentation is key—track hours meticulously to defend against IRS scrutiny.

 

5. 1031 Exchanges for Tax Deferral

  • Allows investors to defer capital gains taxes by reinvesting proceeds from a property sale into a like-kind property.

  • Must identify a new property within 45 days and close within 180 days.

  • Rules are strict—consult a tax professional to ensure compliance.

 

6. Passive Activity Loss Rules & Strategies

  • Rental income is generally considered passive unless you qualify as a real estate professional.

  • Passive losses can only offset passive income unless certain IRS criteria are met.

  • Active Participation Exception – If you actively manage your rental, you may deduct up to $25,000 in losses against other income (phases out above $150,000 AGI).

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7. Capital Gains & Selling Strategies

 

Short-Term vs. Long-Term Capital Gains

  • Properties held for less than a year are subject to short-term capital gains tax (ordinary income rates).

  • Properties held for more than a year qualify for long-term capital gains rates (0%, 15%, or 20%).

 

Opportunity Zones

  • Investing in designated Opportunity Zones can defer or reduce capital gains taxes on property sales.

 

8. Tax Benefits of Short-Term Rentals (Airbnb, VRBO)

  • If you rent your home for fewer than 14 days per year, rental income is tax-free.

  • If actively managed, short-term rentals may qualify for different tax treatment than long-term rentals.

  • Deduct expenses like cleaning fees, maintenance, and property improvements.

 

9. Self-Employment Tax & Real Estate Investors

  • Rental income is not subject to self-employment tax unless you provide substantial services.

  • Real estate flippers and short-term rental operators may be subject to self-employment tax.

 

10. Estate Planning for Real Estate Investors

  • 1031 Exchange into a Trust – Defer taxes and pass real estate assets tax-efficiently.

  • Gifting Strategies – Use the annual gift tax exclusion to transfer real estate to heirs.

  • Step-Up in Basis – Heirs receive a step-up in basis, eliminating capital gains tax on appreciation.

 

Conclusion: Work with a CPA to Optimize Your Tax Strategy

Real estate tax laws are complex, and mistakes can be costly. While this guide provides a comprehensive overview, a CPA can help you implement the right strategies to minimize taxes and maximize profits.

 

Contact Dylan Razzagone, CPA, for a personalized tax strategy session today!

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