This article defines an investor as a homeowner and an owner. A homeowner uses the property as a primary residence, and an owner uses the property to create value and generate income. Both investors enjoy tax benefits.
As a hard-money lender in Los Angeles, I want all real estate investors to know and understand the tax benefits pertinent to their objectives.
The Strategies
Investors can reduce or defer their tax obligations by:
- utilizing the depreciation deduction,
- understanding 1031 exchanges,
- borrowing against equity,
- reducing taxes on capital gains, and
- deducting mortgage interest.
These strategies are available to investors of primary residences and income-producing properties.
Depreciation Deduction
This strategy is available only to investors of income-producing properties. The purchase price of a rental property are recovered through this deduction. The tax code provides this benefit as an allowance for a building’s deterioration by wear and tear, and the loss of value by obsolescence.
The depreciation benefit also extends to personal property like appliances, fixtures, and systems. Structural improvements have a useful life of 27.5 years, and personal property can be depreciated over 7-15 years.
Depreciation is a non-cash expense and can result in a net loss even when the operations generate a positive cash flow. This expense will reduce the investor’s taxable income.
1031 Exchange
A 1031 exchange, named after the corresponding section of the tax code, is a strategy used by investors of income-producing and commercial properties to defer the taxes owed on capital gains when the asset is sold. The concept behind a 1031 exchange is the deferral of taxes owed on the gain if the money is used to purchase another property of equal or greater value.
1031 exchanges add an intermediary to the transaction to ensure the like-kind definition of the exchanged property and to manage the process to meet the time and reporting requirements.
This strategy is the government’s incentive for investment.
Equity
This strategy is available to homeowners and investors. Any owner who has accumulated substantial equity in their property can refinance to monetize the equity. These funds can be used to improve the property or to fund an equity position in another. Borrowing against equity is not limited to investing in real estate.
Using monetized equity is the same as any liquid asset and will not increase the investor’s taxable income.
Primary Residence
Homeowners are real estate investors. Although investors of primary residences are not afforded the same tax benefits as investors of income-producing properties, homeowners can eliminate or reduce the taxes owed on any gain on the sale.
If an investor uses the home as their primary residence for at least two years out of the first five years of ownership, then there is a limit on how much of the gain can be subject to tax.
For an investor who files as a single taxpayer, the first $250,000 in the realized gain from the sale of their home is exempt from taxation. This exclusion is $500,000 for married investors filing jointly.
In some situations, any taxable gain, meaning realized gains over the exclusion, can be used in a 1031 exchange and defer the taxes owed. However, the exchanged property cannot be another primary residence.
Mortgage Interest
Investors and homeowners can deduct the portion of a mortgage payment attributed to interest. This deduction will reduce taxable income.
However, there are limitations, and not all interest can be deducted. According to the tax code, only the interest on the first $750,000 of debt can be used to reduce taxable income. This limitation is $1 million if the mortgage was in place before December 17, 2016.
A mortgage will qualify for this interest deduction only if the proceeds were used to purchase or construct a primary or a second home or used for a business-related investment. Rental homes and commercial properties qualify.
If you are interested in purchasing real estate or need funding for your next project, contact the highly reputable and respected hard money lender in Los Angeles, PB Financial Group. PB Financial is a premier, direct hard money and bridge lender who has been providing quick funding since 2006 and has funded over 2,700 hard money/private money loans. Our objective is to satisfy your financing needs on important real estate projects throughout California in an efficient manner.
To learn more about how to successfully finance your next real estate venture, please contact PB Financial Group at 877.700.3707 to schedule a consultation or visit www.CalHardMoney.com to learn more.
