Tax and Legal Tips When Investing in Real Estate

With the rise of the sharing economy, it’s easier than ever to make money by renting out your home, apartment or spare room on sites like Airbnb. But if you’re looking for a more serious investment, real estate is still a favourite in the international market. It’s been a reliable way to build wealth for centuries, and there are plenty of tax benefits that come along with it. Here are some tips to help you maximize the benefits and minimize any potential drawbacks.

What Benefits Does Real Estate Investing Entail?

Real estate can be an excellent investment, but it’s important to understand how to get the most out of it.

Why is real estate an attractive investment? Because of: 

  • Passive income. Passive income is a common term in the real estate community. It refers to income that is generated without much effort on your part. Some examples of passive income include rental payments and dividends from stocks, bonds, or mutual funds. When you own a piece of property for yourself or for investment purposes, it may generate passive income by providing you with rent from tenants who are paying you for use of the property. You do not have to spend time maintaining this type of property since the tenants will take care of everything themselves (e.g., cleaning).

  • Tax benefits. If you’re investing in real estate, the first thing to remember is that you can deduct the interest on your mortgage and home equity loan. This is called an itemized deduction, which means it’s an expense that lowers your taxable income. If this sounds like a good deal to you, then it might be time to sit down with a tax professional and figure out how much money you could save by paying off your mortgage as fast as possible.

  • Making the most of increased equity. Whether you decide to buy a new property at a lower value and flip it or increase the value of your currently-owned property, it can be a worthwhile investment when done right. If you want to sell your investment property at a higher price than what you paid for it, you can do so by refinancing the loan with a new lender who will give a lower interest rate and/or shorter term on the loan. This will lower the monthly payment amount, which increases income flow each month.

Now that you know about the pros of buying rental property (or simply investment property to hold), here are a few legal and tax-related tips that are worth noting. 

  1. Look Into 1031 Exchanges

This is a tax-deferred exchange of real estate that allows you to postpone capital gains taxes on the sale of investment property. It applies to real estate, business and personal property. In other words: if you sell an investment and use the proceeds to purchase another investment, then you may be eligible for a 1031 exchange. The most important thing about this rule is that it allows investors to reinvest the proceeds from their sale into another property without paying taxes on that gain until they sell their new acquisition (which may be years down the road).

  1. Consider Mortgage Refinance Tax Deductions

The mortgage interest deduction is one of the most popular real estate tax benefits. The Internal Revenue Service allows homeowners to deduct their mortgage interest from their income taxes, which can reduce your tax bill considerably. If you are considering a real estate investment property or have already invested in a rental property and want to refinance your current loan, it may be worth considering taking advantage of this tax break by refinancing your home.

The mortgage refinance tax deduction is similar to the traditional homebuyer’s mortgage interest deduction, but there are some key differences:

  • You must use cash out of pocket for the down payment on your new loan if you’re using this method (you cannot borrow money from family or friends).

  • You’ll need at least 20% equity in order to qualify for this deduction when refinancing an existing home as well as when purchasing a new home.

  1. Set Up Your Business Right And Protect Yourself Against Audits

Being audited by the IRS is not a pleasant experience for any real estate investor. It can be time-consuming, stressful and costly. However, there are several things that you can do to minimize your chances of being audited as a real estate investor.

First, make sure you have all of your tax documents in order and keep them organized in one place so they are easily accessible if an auditor requests them (more on this later).

Next, to set up your business right and protect yourself against audits, you need an LLC. An LLC is a type of business that separates the personal and business assets of its owners. This means that if your property is audited, the IRS can look at only those specific properties that are related to your company. If you don’t want any extra paperwork or fees, consider forming an S-Corp instead; it has many of the same benefits as an LLC without most of the hassle.

  1. Handle Your Real Estate Business Like a Business

In order to avoid tax and legal trouble, you should treat your real estate business like a business. What actionable ways can you achieve that?

  • Have a Business Plan: If you are not sure how to begin creating your own plan for investing or running your real estate business then there are several resources available online that can help guide you through the process.

  • Make Sure You Have Good Accountants and Lawyers on Your Side: If you want to invest in real estate but don’t know what kind of taxes apply to this type of investment, who needs to be paid when selling property or how much money is needed upfront when buying land from someone else then having professional advice from qualified professionals will ensure everything runs smoothly while minimizing any potential issues down the line

Investing in real estate can be a great way to build wealth, but it’s important to understand the tax benefits and how they work. By understanding the tax benefits and legal options available to real estate investors, you can minimize the likelihood of an audit by the IRS and protect yourself from costly mistakes. For example, if you decide not to take advantage of some tax advantages because they seem too complicated or time-consuming, then you could be missing out on opportunities that could help lower your tax bill overall.

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