Building wealth through real estate is one of the best strategies to reduce taxes and gain financial freedom.

However, there are so many complexities when it comes to real estate investing that it can be hard to know whether or not you’re making the smartest financial decisions for your wealth.

In today’s blog, we’re going to focus on the top tax five saving strategies that you should be familiar with (and your real estate tax accountant should have already told you):

The 1031 Exchange

This is one of the most powerful tax strategies in real estate.

The 1031 Exchange allows you to defer your capital gain taxes for years and years into the future. And if you continue doing this over and over again until you die, chances are that you’ll pay ZERO taxes. Because your property gets stepped up in basis when you die, your heirs can turn around and sell it for the Fair Market Value (FMV), and owe ZERO taxes to Uncle Sam.

Of course, there are some rules that you need to follow, such as the 45-day rule to identify the property and the 180-day rule to close.

But the cool thing is that you can use the tax money that you’d have paid the IRS otherwise to fund your next deal.

Tip: Be careful with Cash Boot, as any cash you take from the gain will be taxable to you.

Cost Segregation

If you’re a real estate investor or developer who invests in new construction or renovated real estate, cost segregation study can become one of your best kept secrets.

Cost segregation allows you to accelerate your depreciation expense in the year of study. This gives you a bonus of 5 to 15 years on your interior pieces – from your appliances, light fixtures, water heaters, and your furnace.

This bonus is in addition to your regular depreciation on structure, which is 27.5 years for residential real estate or 39 yrs for commercial real estate.

This will result in higher depreciation and a higher write off in one year, rather than writing the same component over 27.5 or 39 years.

Depending on your modified adjust gross income, you may be able to deduct up to $25,000 losses as a result of your personal income taxes.

Even better, if you qualify as a real estate professional, and you materially participate in your rental real estate activity, you can claim unlimited amount of passive losses against your other income.

Long-Term Capital Gains

If you hold your real estate for more than one year and sell it at a gain, the gain is taxed at a preferable long term capital gain tax rate, which is 0, 15%, or 20%.

The rate depends on your ordinary tax rate in the year of sale. (Don’t forget to add your state income tax in your tax analysis.)

So, if you live in a no-mercy tax state, like NY or CA, your long term capital gain is taxed as ordinary income – no special tax treatment.

Also, when you sell your investment at a gain, you may be subject to depreciation recapture.

Depreciation taken on 5, 7, or 15-yr properties, or any access of straight line depreciation will be recaptured on the year of sale, subject to 25% or your ordinary income tax rate, depending on the type of asset.

One way to avoid depreciation recapture is by doing 1031 Exchange.

Another strategy is to buy a new property and run a cost segregation in the same year. The loss from the cost segregation may cover some, or all of the gain from the property you’re selling.

Flipping Real Estate

Flipping real estate is a tricky business, and can be problematic from a tax perspective.

Think about it as facing a fork in the road.

Flipping can be treated as an investment if you buy real estate with the goal of keeping it for appreciation, then selling it down the road. It can be looked at as the sale of an asset, which is when a favorable capital gain tax comes into play.

The other fork is being considered a dealer. Your real estate investment is treated as inventory from a tax perspective in this case. So, when you sell the investment, the long term capital gain tax goes completely out of the window. Your sale generates an ordinary income, subject to ordinary income tax rates. Not only ordinary taxes, but if you operate as a sole proprietor, the income will be also subject to self employment taxes.

We recommend working with an experienced real estate accountant to set up your property flips in the most tax advantageous way. If you don’t have a real estate accountant you’re happy with, you can book a free 15-minute call with us anytime.

Short Term Rentals

Having short term rentals is a great tax saving opportunity for real estate investors, as long as it’s structured properly.

Contrary to popular belief, not all AirBnbs are considered short term rentals from a tax perspective.

You’re running a short-term rental if your customer’s average stay is 7 days or less within one year.

And if you materially participate in managing the rentals, your loss is treated as ordinary loss and can offset your W2 income.

Pssst.. here’s another bonus: cost segregating your short term rental will generate a HUGE loss in year one, which you can use to offset your ordinary income.