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Big Tax Breaks for Real Estate Investors
Not only are homes at record affordability levels, real estate ownership also opens the door to a wide variety of tax benefits and additional savings.
“A recent poll shows that 75 percent of likely voters think real estate tax deductions are appropriate and reasonable,” said Steve DiUbaldo, president of Atlantic & Pacific Real Estate, a full-service real estate brokerage with offices in 22 states. “People understand the value of owning a home and the role played by tax benefits. Combine today’s affordability levels with tax advantages and now is a very good time to consider both residential and investment real estate.”
So what are the biggest real estate tax breaks? For most owners and investors the list of major tax write-offs looks like this:
1. Property Taxes. Real estate owners can write off the cost of state and local property taxes. For many borrowers this deduction can reduce taxable income by thousands of dollars.
2. Mortgage Interest. The IRS defines a home mortgage as “any loan that is secured by your main home or second home. It includes first and second mortgages, home equity loans, and refinanced mortgages.”
Mortgage interest can generally be written off, but not always. The limitation for mortgage interest on a primary and secondary residence is a total of $1,000,000 for acquisition indebtedness and $100,000 for home equity indebtedness. There are lower limits for individuals and those who are married but filing separately.
3. The Standard Deduction. “Everyone is entitled to a standard deduction,” said DiUbaldo. “However, write-offs for mortgage interest, property taxes, mortgage insurance premiums and other costs generally allow real estate owners to justify itemizing expenses and thus larger write-offs.”
4. Mortgage Insurance Premiums. Mortgage insurance allows purchasers to buy with less than 20 percent down. Qualified borrowers can get FHA financing with 3.5 percent down, conventional loans can require as little as 5 percent down and VA purchasers can borrow with zero down. Closing costs are extra.
“In general,” says the IRS, “if you itemize deductions, you may deduct premiums paid for mortgage insurance provided by the Department of Veterans Affairs (VA), the Federal Housing Administration (FHA), the Rural Housing Service (Rural Housing), or private mortgage insurers in connection with a mortgage for the purchase of your main home.”
5. Points. A “point” is a fee to the lender equal to 1 percent of the mortgage amount. Borrowers often have the option of paying points at closing rather than a higher interest rate over the life of the loan. Whether it’s better to pay points or accept a higher interest rate depends on such issues as the interest rate, the number of points and how long the property will likely be held.
In general, a point paid at closing for acquisition financing is fully deductible in the year paid. If a point is paid to refinance a home, the point is deductible over the term of the mortgage, typically 1/30th per year.
6. Investors can claim Depreciation. Depreciation allows investors to take an additional tax deduction because a real estate “improvement” is believed to wear out over time and will need to be replaced.
“Depreciation is an accounting concept,” said Atlantic & Pacific Real Estate’s president. “The investor is not actually spending the cash represented by the ‘cost’ of depreciation and one result is that it’s possible to have an investment property which produces a positive cash flow that is partially or wholly not taxable currently. In certain instances, subject to individual taxpayer limitations, it is even possible to show a loss for tax purposes.”
7. Sale Profits. When a prime residence has been occupied for two of the past five years it’s probable that much or all of the profit will be sheltered from capital gains. With a joint return up to $500,000 can be protected, $250,000 for an individual owner. Example: You bought a home in 1990 for $100,000 and sell it in 2012 for $300,000. There’s a $200,000 long-term profit, none of which is taxed.
If you’re an investor, sale profits are taxed as long-term capital gains if the property has been owned for at least a year. That means long-term capital gains in 2012 are generally taxed at 15 percent.
8. Tax-deferred exchanges: The National Association of Realtors says investors purchased 23 percent of all existing home in January. One reason for such interest is that it’s possible to have tax-deferred real estate exchanges with investment property.
“You can swap one investment house for another, but you can also trade a rental house for a commercial property or a property with four units,” said DiUbaldo. “An exchange can allow an owner to defer capital gains taxes for years if not decades, and swaps are one of the reasons investors come to our website ( www.apreus.com ).”
The Bottom Line: Whether purchasing as an owner-occupant or as an investor, tax rules can powerfully impact the value of your real estate. For the latest information, details and deductions be sure to check with a local tax professional.
As always, we urge you to consult with your own independent Certified Public Accountant as to the appropriateness of any tax deductions for your specific circumstances. Article by Market Watch.