Tax Planning Tips for Real Estate Investors

Investing in commercial real estate offers numerous advantages, with one of the most significant being the potential for substantial tax benefits through direct real estate ownership. When executed strategically, investors can effectively minimize their tax liabilities, allowing them to exponentially grow their wealth.

With tax season currently underway, now is the perfect time to revisit common strategies and essential tax planning tips that every real estate investor should be well-versed in.

Here are three tips to help guide you through the 2024 tax season.

Prepare All Essential Documents

As you begin planning what you’ll need this tax season, make sure you have all essential documents ahead of time. For business partners, S corporation shareholders, or beneficiaries of trusts and estates, the main item you’ll need is a Schedule K-1 – a federal tax document used to report the income, losses, and equity accounts. This tax form is used to report one’s share of any taxable items, such as:

• Funds contributed
• Distributions received
• Depreciation (which can come from Cost Segregation Studies)
• One’s pro-rata share of income and expenses at the property
• Qualified Business Income (QBI) deduction information

The partnership deadline for receiving Schedule K-1s is March 15th, which allows investors one month to complete individual taxes before the last day to file, which is April 15th.

Minimize What You Owe

Consider which tax-efficient vehicles make sense for your portfolio. A few common ways real estate investors can save on taxes are through:

Bonus Depreciation
With bonus depreciation, businesses can immediately expense eligible assets in their first year of service instead of depreciating over a certain timespan. This can offset income in the first year after acquiring a new property.

When used effectively, bonus depreciation will lower the amount of income tax you pay in the current period while also generating passive income through your investment. To do this, businesses may implement a cost segregation study, identifying all property-related costs that can be depreciated faster per IRS guidelines.

• As of February 2024, Congress has proposed significant changes to the Child Tax Credit Bill that could directly impact bonus depreciation. It aims to increase the child tax credit amount and expand its refundable portion. Specifically, the bill suggests raising the refundable portion cap to $1,800 per child for 2023, $1,900 per child for 2024, and $2,000 per child in 2025. Additionally, it introduces inflation adjustments to the $2,000 credit starting in 2024. The bill also allows tax filers to use their earned income from the current or prior year (whichever is greater) when calculating the credit. The proposal would restore bonus depreciation to 100% for qualified property placed in service from 2023 through 2025. While the Child Tax Credit Bill has been passed by the House of Representatives, its fate in the Senate remains uncertain. The bill’s impact on businesses and taxpayers could be significant if enacted, affecting tax planning strategies and financial decisions. We recommend keeping an eye out for any pronouncements of new incentives that could impact your tax position.

1031 Exchange
The IRS has another tax benefit to encourage investors to utilize their funds in real estate investing called a 1031 exchange. This exchange allows you to sell one of your real estate investments and purchase another; therefore, deferring a portion of the tax bill from the gain to a later date. This tax strategy is referred to as “Deferred Capital Gains” and allows you to take advantage of investing, and deferring the taxes that would normally be due at the time of sale.

Step-Up in Basis for Beneficiaries
A Step-Up in Basis is a tax benefit used for building generational wealth, and comes into play with end of life and estate planning phases. When you leave the investment to your beneficiaries, they will receive a step-up on the basis of the investment. This means they can raise the value of the investment to the current day, fair market value and pay no taxes on the difference in gain.

Individual Retirement Account (IRA)
Investing through an IRA can help minimize taxes in several ways. Contributions to a traditional IRA are generally deducted from your taxable income immediately, potentially lowering your current tax bill. By contributing to an IRA, you can reduce your adjusted gross income (AGI) dollar-for-dollar, which can lead to significant tax savings. Conversely, contributions to a Roth IRA allow for tax-free growth on earnings and tax-free withdrawals in retirement, potentially reducing your lifetime tax bill. Many investors will also choose to open a self-directed IRA, which unlocks the door to invest in alternative assets, like real estate. With a self-directed IRA, you have the freedom to choose individual properties for investment and can invest with pre-tax dollars, or even have your investments be tax-free forever on those gains in the case of a Roth.

3. Work With A Tax Professional

Given the complex nature of real estate tax laws, it’s always a good idea to work with a professional that can guide you in the right direction based on your specific situation. A tax professional can be beneficial for many reasons:

• Help to fully optimize your tax saving strategy:
  Beyond a one-size-fits-all approach, a tax professional tailors strategies to your unique circumstances. They analyze your financial portfolio, taking into account factors such as property investments, income sources, and deductions. This personalized approach ensures that every available avenue for tax savings is explored, maximizing your financial benefits.
• Assist in identifying potential risks:
  Real estate transactions often come with inherent financial risks. A tax professional not only helps you navigate current tax laws but also identifies potential risks that may impact your tax position in the future. Their proactive analysis can save you from unexpected financial burdens and legal complications down the road.
  
• Ensure compliance with tax laws and regulations:
  Tax laws are subject to constant changes and updates. A tax professional stays abreast of these changes and ensures that your real estate transactions comply with the latest regulations. This proactive approach helps you avoid penalties, audits, and legal challenges, providing peace of mind and financial security.

By collaborating with a tax professional, you not only gain insights into optimizing your tax strategy but also benefit from a proactive ally who safeguards your financial interests.

Takeaway

Being proactive and having a well-informed approach to tax planning can empower you to take full advantage of the available benefits, reduce effective tax rates, and pave the way for sustained financial success. As the tax season unfolds, we encourage you to implement the three tips above and collaborate with a professional to fully optimize the benefits of real estate investing.

If you’re an accredited investor looking to access the full tax benefits of direct real estate investing, we’d love to connect with you. Simply fill out this form to get in touch.

Sources:

https://money.usnews.com/money/retirement/iras/articles/how-to-make-a-last-minute-ira-contribution

https://www.investopedia.com/ask/answers/102714/do-ira-contributions-reduce-average-gross-income-agi.asp

https://www.forbes.com/advisor/retirement/last-minute-ira-contributions/

https://www.calt.iastate.edu/blogpost/tax-bill-impacts-filing-season

https://missouriindependent.com/2024/02/16/expanded-child-tax-credit-could-be-in-place-quickly-if-passed-by-congress-irs-chief-says/

https://www.finance.senate.gov/imo/media/doc/the_tax_relief_for_american_families_and_workers_act_of_2024_technical_summary.pdf

https://rsmus.com/insights/tax-alerts/2024/tax-relief-bill-passes-house-faces-uncertain-fate-in-senate.html

https://www.journalofaccountancy.com/news/2024/feb/house-oks-78b-tax-bill-with-changes-to-erc-and-child-tax-credits.html

Disclaimer: The information in this blog post is for general informational purposes only and not professional tax advice. It’s based on 2024 information and may not reflect current tax laws. Investing in commercial real estate involves risks, and tax laws can change. Readers should consult with a qualified tax professional or financial advisor for advice tailored to their circumstances. The tips may not be suitable for everyone, and Excelsior is not responsible for any actions taken based on the information. It is essential to verify information independently and seek professional advice before making financial decisions.