What Taxes Do You Need To Pay On Your Real Estate Investment?

This is a collaborative post by Ellie Jo about taxes. 

Real estate investments are a popular choice for people that want to secure their financial future. The value of property historically goes up. Sometimes there are dips, but over time real estate tends to appreciate.

Plus tenants pay off any mortgages you hold on the house..

So if you can save the money for a down payment on a property, over a long enough time line you may get a great return on your investment. 

Unfortunately, people often forget about taxes when budgeting for a property investment and it comes back to bite them later.

There are a number of different taxes you will have to pay when owning a property. There are also taxes when earning a profit from investments. You need to be prepared to cover these costs. These are the taxes you need to pay when investing in property. 

Real Estate Taxes 

Real Estate Tax is a tax that you may have to pay on property. There is no federal real estate tax. It all comes down to a state level. In some cases, states will charge a different form of property tax instead.

Either way, it is likely in many places that you will have to pay some kind of tax when owning the property

It is calculated as a percentage of the value of the home. You can use a stamp duty calculator to work out how much you will have to pay on the property. It’s important that you do this during the budgeting stage, so you can make sure that you can afford it.

If you forget about paying property taxes, you will struggle to manage your finances when it comes time to close on your new real estate investment. 

Check with the local authorities so you know exactly what kind of property taxes you will have to pay. 

Income Tax On Real Estate Taxes

If you buy a property and rent it out, you must be aware of the tax implications. People are often confused about how the IRS views the money that you earn from rental properties but it’s not as complicated as you might think.

With a rental property, the money that you earn is treated in the same way that any other income is, so you will have to pay standard income taxes on it. This also includes any rental deduction that you agree with the tenant.

For example, if they agree to decorate the home in exchange for a $100 rent reduction for the next few months, that money still counts as rental income even though it hasn’t been paid in cash. 

When calculating the income tax that you owe, there are a lot of deductions that can help you reduce the bill. Any costs associated with maintaining the property are tax deductible. Your mortgage interest, insurance costs and other property taxes are also deductible. 

Real Estate Depreciation

Real estate investors also benefit from a depreciation expense deduction. This is often used by businesses when buying an expensive piece of equipment with a long lifespan. Instead of being deducted in one year, the cost is split over multiple years and deducted each time.

The same can be done with a property investment over a period of 27.5 years, meaning that many investors do not pay income tax on their property as a result. 

Capital Gains On Real Estate

When you sell your real estate there will be a tax on capital gains. The taxes are different if you hold the real estate less than 12 months (aka if you are a real estate flipper).

Depreciation Recapture

Depreciation is a tax deferral, it isn’t tax free. When it’s time to sell there is a “depreciation recapture” tax.  Basically it’s an additional capital gain tax and it’s a real expense. What’s more, is depreciation recapture applies even if you don’t depreciate your real estate.

In Conclusion: Real Estate Tax Expenses

If you manage your tax affairs in the right way, you can save a lot of money. So, make sure that you have a full understanding of exactly what you owe and consider speaking to an accountant if you are unsure.