Owning real estate is not just a part of the American Dream, it is an opportunity to have a stable means of livelihood both as a residence and investment.
In fact, real estate is one of the most stable assets you can own due to the potential for appreciation and income growth. As with many assets in the US, there are tax benefits designed to encourage investment in real estate. Here are some deductions for home-related expenses as well as some tips on future investing.
- Mortgage Interest Deduction
One of your biggest tax breaks is reflected in the house payment you make each month. For most homeowners, the bulk of your mortgage payment goes toward interest. This interest is deductible for both your primary residence and also for your second home. In Tax Cuts and Jobs Act from 2018, interest paid on Home Equity Line of Credit (HELOC) and home equity loans are no longer tax deductible unless the associated debt is obtained to build or substantially improve the homeowner’s dwelling. The limit for equity debt used in origination or home improvement is $100,000. Interest on up to $750,000 of first mortgage debt is tax deductible.
- Mortgage Points (Origination) Deduction
Homeowners who paid points (origination fees) can often deduct those on their tax returns. However, the homeowner can deduct the entire amount they paid for those points in the same year of the purchase or loan origination. If you refinanced your home for home improvements, those fees must be amortized and deducted over the life of the loan.
- Rental Property Deductions
Rental properties offer more tax deductions than most investments. The IRS allows you to deduct expenses for upkeep and maintenance of your property including management fees and other expenses. Here are some general expenses that are deductible:
- Utilities Insurance
- Repairs Maintenance
- Association fees
- Management fees
- Travel costs incurred while doing business
- Professional and legal fees
Depreciation is the loss in value of a property over time due to physical deterioration. The IRS allows an investment property owner to take a tax loss every year based on the depreciation over the useful life of the asset. For residential property you can depreciate your property over a cost-recovery period of 27.5 years and for commercial property 39 years.
- Real Estate (Property) Taxes
Homeowners can deduct the local property taxes paid each year. If property taxes are paid through an escrow account from the lender, those payments cannot be deducted. Only the actual real estate tax amounts paid out of the account during the year can be deducted. The Tax Cut and Jobs Act puts a limit of state and local taxes (including property taxes) to $10,000 per year.
- Capital Gains
When a primary property is sold, the capital gain is the difference between the price a homeowner paid for and the price it’s sold for. The tax law allows you to shelter a large amount of profit from tax if certain conditions are met. If the homeowner is single and has owned and lived in the home for at least two of the five years before the sale, then up to $250,000 of profit is tax-free. If married, up to $500,000 of the profit is tax-free if one spouse (or both) owned and lived in the home as a primary home for two of the five years before the sale.
- A Tip for Re-investing in Real Estate
If you own investment property and would like to realize the appreciation of this investment without paying capital gains tax upon the sale? You may want to consider a 1031 tax deferred exchange which allows you to sell an investment property and purchase another investment property and defer the capital gains tax that you might otherwise have to pay. There are certain rules in place such as identifying your replacement property (up to 3) within 45 days from the sale of your current property and closing within 180 calendar days. Also, you would want to purchase a replacement property of equal or greater value to avoid paying capital gains tax in the process.
For more information regarding the tax benefits of owning real estate please contact us.