Real estate investment is a great way to develop a passive income source. While you work your 9-5 job, you’re also guaranteed revenue and capital gains through rental income and property appreciation, respectively.
If you’re particularly successful, you can even drop the job and focus on something else you enjoy while having a reliable income stream from your real estate investment. However, real estate investment offers more than just an income stream; it also comes with an assortment of tax benefits. Here are some of them.
Depreciation
Depreciation refers to the reduction in an asset’s value due to wear-and-tear, obsolescence, etc. The IRS provides guidelines for how to depreciate your asset, but that’s not where the tax benefit rests. Depreciation is a paper loss. For instance, if your house’s value decreases, you don’t pay anyone, but the provision for depreciation is still treated as an expense. Consequently, depreciation reduces your taxable income without you actually paying anything. However, this reduction may be offset by a capital loss in your asset’s value.
FICA
FICA refers to the Federal Insurance Contribution Act. This is a U.S. law that enforces a tax on employees and employers to fund Medicare and Social Security programs. This amount is taken directly from a person’s pay, and one can’t opt out of paying the tax. However, there are some kinds of incomes, such as rental income, that aren’t subject to FICA.
Refinancing
Refinancing refers to the process of replacing a current credit arrangement with another credit arrangement under different terms and conditions. Refinancing has an assortment of advantages, such as lower interest rates, reducing monthly repayments, and freeing up cash. The last advantage is particularly relevant to refinancing a real estate investment.
If your real estate has accrued significant equity, you can pull out that equity by cash-out refinancing your property. Cash-out refinancing involves extracting the appreciated value of your property by establishing a higher loan amount, which is non-taxable. While this does increase your debt, you also get more cash, which you can use to improve your property or invest elsewhere.
To fully leverage the tax benefits of real estate investment, it’s best to consult a specialist tax accountant. For a CPA firm specializing in real estate, get in touch with us, at Harmon/Harmon. We operate in Austin, TX, and we offer accounting services for real estate and tax planning and compliance services for real estate agents and brokers.