Although Wall Street can offer investors tax advantaged vehicles like the tax free municipal bond or the ability to buy and sell stocks through an IRA, the tax advantaged vehicles Wall Street put forward pale in comparison to those offered by real estate.  With real estate, there are tax advantages available while both owning and selling real estate.    Let’s first discuss the advantages available during the course of real estate ownership:
Mortgage Interest Expense
The federal government allows all of the interest associated with the financing of the property to be written off as an expense of owning the property.  For many real estate investors, especially those with interest only loans, this expense deduction can be substantial.

Depreciation
Depreciation is a method for matching the costs of acquiring property over the properties estimated economic life. The IRS now requires that most properties be depreciated using the straight-line method of depreciation (27.5 years for residential properties, 39 years for commercial properties).  Depreciation will act as an intangible expense and will shelter income from taxes.  

Expense Deductions
Many of the costs associated with owning and managing a real estate investment, such as management fees and insurance premiums, are deductible.  One deductible expense worthy of note is the travel expense.  Many real estate investors acquire real estate in places they like to (or have to) visit, and each time they travel to the property, the travel costs are a deductible expense.  Not a bad deal if the property happens to be in Maui, or around the corner from a relative.  

Passive Losses
Due to depreciation and expense deductions, it is possible to own a property that is producing positive cash flow, but for tax purposes showing a loss.  These “passive losses” are subject to certain restrictions, but in many circumstances can be used to offset passive income from another investment.      
There are also specific tax breaks available when selling real estate.  The tax breaks available depend on the type of real estate sold. If a primary residence is sold, Section 121 of the Internal Revenue Code allows the seller to avoid paying capital gains taxes.  If an investment property is sold, Section 1031 of the Internal Revenue Code allows the seller to defer the payment of capital gains taxes.  Both sections of the tax code merit further discussion:
Section 121
Upon the sale of a primary residence a taxpayer can avoid paying capital gains taxes on the first $250K of gain if single, or the first $500K of gain if married.  The seller(s) must have lived in the home as their primary residence for two out of the past five years.  

Section 1031
Upon the sale of an investment property a taxpayer can defer the payment of capital gains taxes.  In order for the entire tax liability to be deferred, the taxpayer will need to reinvest all of the sale proceeds and purchase a property of equal or greater value.  The new property must be acquired within 180 days.
Many investors can use both Section 121 and Section 1031 together for maximum tax advantage.  An example would be an investor who conducts a 1031 Exchange into a rental home.  After establishing the property as a rental for two years, the investor moves into the property.  Once the property is established as a primary residence, some taxes can be avoided on the sale via Section 121. 
 
**One of the Last Tax Shelters
 
The §1031 Tax Deferred Exchange is one of the last tax shelters allowed by the Internal Revenue Service.  It is a transaction in which a taxpayer exchanges investment property for like- kind investment property, which defers the payment of capital gain taxes and the recapture of Deprecation taxes.  The IRS defines like-kind property as all real property held for investment purposes, or the productive use in a trade or business.  This basically includes any real estate held for investment except your primary residence and second family home.
 
There are some important rules which must be followed to effectuate a valid exchange:
 

• The exchange must be opened before the close of Escrow on the relinquished (sale) property.

 

• The taxpayer must identify the replacement (acquired) property within 45 days after the close of the relinquished (sale) property.

 

• The taxpayer must close Escrow on the replacement property within 180 days from the close of the relinquished property, or, before the date the tax return filing is due for the tax year in which the relinquished property was transferred - whichever comes first.

 

• The taxpayer must reinvest all net proceeds into the replacement property.

 

• The taxpayer must obtain a debt of equal or greater amount on the replacement property.

 
By following these rules, the taxpayer shelters capital gains tax into the replacement property, and defers the recapture of depreciation tax.  This creates more buying power for the taxpayer than if the capital gains tax was paid.  Also, by deferring the payment of capital gains tax, the taxpayer gets to invest the taxes into the replacement property interest free from the IRS.  The 1031 Tax Deferred Exchange also avoids the California Withholding Tax.
 
**7 Important Questions Every Investor Needs to Ask
 
Real Estate Investors continue to look for ways to manage their investment portfolio and to create the most of its potential.
 
Here are 7 essential questions to consider:
 
1-   How do I maximize the equity which has grown in recent years and leverage it into a better real estate portfolio, with greater cash flow?
                                       
2-   How hard is my rental property working, and is there a way to measure its cash producing performance?
 
3-   Am I utilizing all the Depreciation tax breaks I can?
 
4-   How can I reduce the stress and time spent managing my properties without sacrificing income or growth potential?
 
5-  Can I reduce my risk factors including market adjustments               
      by diversifying my portfolio?
 
6-  Am I holding Title to my properties in a way to protect             
            my estate?
 
7-  How can I minimize or defer the tax burden for myself and  
my heirs, and still grow my asset base?      
 
In most situations, investment property amounts to our most important and lucrative investments.  Doesn’t it make sense to maximize their growth and potential?
 
If you’re not sure of the answers, please feel free to call.  As real estate professionals, we are here to provide you with direction in these areas. 
​
​