Buying an investment property can help you generate additional income, give you greater financial security and provide tax advantages. Here are some things you should know if you’re thinking about investing in real estate.
Property Taxes
If you own an investment property, you’ll have to pay taxes to the local or state government to fund roads, schools, emergency services and other priorities. The amount you’ll owe will depend on the property’s value and local tax rates, which can vary widely.
Income Taxes
If you rent out an investment property, you’ll have to pay taxes on your net rental income. That’s the amount you earn in rent, minus what you spend to manage and maintain the property and get it ready to be rented out.
If you own an investment property that you rent out or use as a business, you’ll be able to write off a portion of the cost of the property each year when you file your taxes. You’ll also be able to deduct depreciation for certain types of home improvements. Depreciation will decrease the amount you’ll owe in taxes.
Your net rental income will be taxed at the same rate as money you earn from your regular job. You won’t have to pay Social Security or Medicare (FICA) taxes on money that you earn by renting out a property.
Capital Gains Taxes
When you sell an investment property, you might have to pay capital gains taxes. You will have to calculate the cost basis, which is the amount you paid for the property, plus acquisition costs and the amount you paid to improve the property, minus depreciation. If the sale price is more than the cost basis, you’ll have to pay capital gains taxes.
How long you owned the property will affect your tax bill. If you owned it for less than a year, you will have short-term capital gains that will be taxed at the same rate as ordinary income. If you owned the property for more than a year, you’ll have long-term capital gains that will be taxed at a lower rate. Since real estate tends to increase in value over time, owning a property for more than a year can provide a significant tax benefit.
Investing With a Partner
If you and one or more partners have a real estate limited partnership, each of you will have to pay taxes on your share of the RELP’s income. Each partner will receive a Schedule K-1 that shows that individual’s portion of the investment’s net income.
Consult a Tax Professional
Everyone’s situation is different, and tax rates can vary widely by location. Before you invest in real estate, meet with a tax professional to talk about how your earnings would be taxed and ways to limit your tax liability.
