Owning property is an investment that can build wealth as well as a good way to cut down on taxes. Home Improvement exemptions, purchasing in opportunity zones, and depreciation deductions are just some ways taxpayers can save on property taxes this season. Here’s how.
Offsetting a Tax Bill with Real Estate
Investing in real estate can help save on taxes in a number of ways, including:
- A depreciation deduction
- Tax deferments via 1031 exchanges
- Borrowing against home equity
To use the depreciation deduction, the property must produce income through rentals. The IRS defines the depreciation deduction as a reasonable allowance for deterioration, wear and tear, and a reasonable allowance for obsolescence. Investors assign a time frame for depreciation, which, if they follow the Modified Accelerated Cost Recovery System, designates 27.5 years for structural improvements and 15 years for appliances and other fixtures. Depreciation expenses often result in a net loss on the investment property. That loss, plus expenses, utilities, and insurance, are reported on Schedule E of the Form 1040 tax form.
1031 Exchanges are named for IRS Revenue Code Section 1031, which allows investors to defer taxes by selling an investment property and using the equity to purchase another, of equal or greater value within a specified amount of time. Properties must meet criteria, such as: the combined value of the replacement properties must be equal or greater than the value of the relinquished properties, the properties involved must be “like-kind,” meaning that real estate property cannot be exchanged for another type of asset, and both properties must be held for” productive purposes in business or trade,” i.e., an investment.
There are additional regulations that govern this type of tax break, so property owners should read the full regulation before attempting to use this tax break.
Similar to this tax break, real estate investors might consider purchasing property in what the U.S. Department of Treasury calls “opportunity zones,” which are low-income or disadvantaged tracts of land.
For investors who have built up equity in the property, refinancing the property to pull out the equity to make improvements on the property could allow the property to be eligible for a Home Improvement Exemption as long as the improvement adds to the value of the property. The Home Improvement Exemption will keep the property from being taxed on up to $75,000 of the added value of the property for up to four years.