Note that tax benefits are a bonus, not a reason to buy real estate. The idea is to make money first, and then save taxes on the income you receive.
How many of you would agree that the greatest expense you will have in your lifetime is taxes? Real estate can help you avoid taxes legally. There is a big difference between tax evasion and tax avoidance. We simply want to take advantage of the legal tax ‘loopholes’ that Congress allows us to take, because since the founding of the United States, the laws have favored property owners. Today, the tax laws still contain ‘loopholes’ for real estate investors. Congress gives you all kinds of financial reasons to invest in real estate.
When you look at earned income, such as wages from your job, you could possibly be paying taxes on 50% of that income, counting federal, state, and FICA (Social Security and Medicare). If you sell a property you have owned for a year or more, the profit is considered investment income, and you pay only long-term capital gains tax on it, which is currently at 15%, which is a much better rate then 50%! If you hold the property as a rental property and you set up your real estate business correctly, the cash flow is considered passive income, and you pay no tax whatsoever.
You can do even better than the capital gains rate if, instead of selling, you simply do a cash-out re-finance. The proceeds are tax-free! By the time you figure in taxes and selling costs, you could come out better by re-financing with more cash in your pocket than if you sold it outright, plus you still own the property and continue to benefit from the income on it!
Depreciation is one of the biggest tax benefits of all. Even though the property appreciates, Congress allows you to take a deduction for the depreciation, which assumes that it goes down in value. For example, you may own a property that is generating $15,000 a year in rental income and your expenses for that property is $8,000 a year. That leaves you with a pre-tax profit of $7,000. However, you may have a depreciation allowance of $8,000, using the charts from the IRS. Rather than having to pay tax on the $7,000 profit, your net income after deducting depreciation would be negative $2,000! In reality, you are making a $7,000 profit that is yours to keep, but as far as the IRS is concerned, you are making a loss of $2,000. This is known as a ‘paper loss.’ This ‘miracle’ deduction not only prevents you from paying taxes on your real estate, but can offset income from other sources, such as earned income from your job, as long as you meet certain IRS qualifications.
I call you blessed!