When I meet a new investor, I always discuss how it is critical to building a team of advisers to support your Real Estate Investment career. One of my advisers is my CPA, John Caylor. As we head into tax season, I decided he should be our first guest writer of 2008 to discuss the tax implications of owning Investment Property:

Let’s Talk Taxes

by John Caylor, CPA

So, you are thinking of buying some rental properties? Or maybe adding a few more to your portfolio? There are many reasons to own real estate beyond the joy of maintaining properties and tenant relations.

A well analyzed real estate purchase can be a great part of your retirement portfolio, and can be very similar to a tax deferred retirement plan, such as a 401(k). The difference is with a 401 (k), the IRS tells you when you can retire and start drawing the income while a rental property

retirement portfolio can be accessed any time penalty free (in other words, you can pick your own retirement date).

An example is a property that is purchased for $100,000. If the property grows at an average rate of 5% per year, you are getting tax deferred asset growth, or investment income. You are not taxed on an increase in property value until a sale occurs. Even then a Like Kind Exchange can defer the taxes even further. If you put that same $100,000 in a mutual fund, you would be taxed annually on the investment income (growth) of the account, and in a 401(k), the income is tax deferred but locked up until IRS defined retirement.

Also, in many cases the tenants are paying for the property for you via rent, so there may be no money out of your pocket to fund your retirement. In a 401(k) setting, almost all of the money to fund the account is directly from your pocket.

In addition to the tax free asset growth, there is current tax benefit to owning real estate. In a rental property situation, you can deduct all operating costs associated with owning the property as well as depreciation of the property. Depreciation is a deduction of the cost of the property over time, normally 27.5 years. Example; a $100,000 property would generate $3,636 ($100,000 / 27.5 years) tax deduction each year.

These tax deductions can be deducted directly against rental income, or other taxable income. Keep in mind there are some limitations to be considered. Please consult with your tax advisor for more details.

Note: If the property is an investment property, rather than a rental, you do not get to deduct current expenses. These costs are generally accumulated over time and upon sale of the property, they reduce the gain on sale, very similar to a stock buy and sell. You also cannot deduct depreciation on an investment property.

Another benefit to real estate is most gains on sale of property are taxed at the favorable capital gains rates, rather than ordinary income. This can make a major difference in total taxes paid and when adding the lower capital gains rates to the operating expense deductions and depreciation, you can see the long term tax benefits to real estate.

In summary, there are many reasons to own real estate, and the tax benefits rank as one of the most significant.

Please contact my office with any questions you may have.

Sincerely,

JOHN D CAYLOR, CPA
JOHN@CAYLORLTD.COM
952-767-9070