Tax strategies and benefits your real estate investor clients should be aware of

This article was provided by RCN Capital

In the real estate investment industry, a broker that can demonstrate value beyond the loan process becomes an asset that every investor wants to work with. The next step for brokers is to become a trusted advisor that provides strategies and solutions for their clients, especially ones that save money. One of the underrated aspects of investing in real estate is the tax benefits and strategies investors can employ to solidify their bottom line.

The best people to ask about these benefits are certified tax professionals, but it is still worth mentioning the basics as it pertains to a few strategies that brokers can use to help their clients where it matters most. These insights can significantly impact their profit margins and long-term investment success.

Going pro

The first tax break for real estate investors worth mentioning is earned when an investor achieves Real Estate Professional Status (REPS). The first step to qualifying for this tax break is an being an investor that dedicates at least 750 hours and more than 50% of their working time to their real estate business. This can be any number of tasks associated with the industry but encourage your clients to start tracking their tasks and spending their time strategically to hit that hour mark and percentage threshold.

REPS enables real estate professionals to fully offset rental losses against other forms of income, thus reducing their overall tax liability. Additionally, REPS allows individuals to take advantage of accelerated depreciation on rental properties, resulting in larger upfront deductions during the early years of ownership. This leads to a domino effect that enhances cash flow and minimizes taxable income.

By treating rental income as active rather than passive, real estate professionals may also avoid the 3.8% Net Investment Income Tax (NIIT), further decreasing their tax burden. If done the right way, REPS can be a strategy that propels real estate investors to greater heights earlier on in their career rather than struggling right out of the gate. Be sure to consult a tax professional to learn more ways a real estate investor client can use REPS to help them.

Accelerate success with the 1031 Exchange

In real estate investment, the adage, “having your money work for you” is achievable through the 1031 Exchange strategy. Simply put, the 1031 Exchange is an IRS-approved tactic that allows investors to defer paying capital gains taxes when they sell an investment property under the condition that the proceeds from the sale go directly into another investment property of equal or greater value. Another strategy that not only saves money on taxes but also encourages one to grow their portfolio, the 1031 Exchange is important to consider for all investors.

While the benefits are always worth discussing, even more so is the timeline in place to successfully execute a 1031 Exchange. This is where brokers can meet with a tax professional to ensure they are receiving and relaying the right information to their clients about this strategy. Here’s a quick breakdown of a successful 1031 Exchange per the IRS:

1. An investor sells an existing property
2. Within 45 days, the investor targets a replacement property of equal or greater value
3. The subsequent purchase must be completed within 180 days
4. The purchase of the new property must be funded by a neutral third party that complies with the rules set in place by the IRS (this third party is often referred to as a Qualified Intermediary)

Make sure you are up front with your client about the need to meet these deadlines. Any misstep could trigger a financial penalty and render the strategy useless.

The benefits that brokers should be stressing to their investor clients include tax deferrals, portfolio growth with higher valued properties, increased purchasing power and estate planning advantages. It is one of the most effective strategies for real estate investors, and brokers that can bring this to the table will be a trusted asset for years to come. However, it’s a complex process that demands precise timing and professional insight from a trusted tax professional.

Opportunity (zones) knocks

Another strategy that can lead to major benefits from a tax perspective for investors is investing in Opportunity Zones which are designated by the IRS and U.S. Treasury. These zones are set up by the government to encourage economic activity and development in underserved areas. Opportunity Zones came about recently in 2017, so there is a high probability that most investors either aren’t aware of these zones or aren’t aware of the benefits that come with investing in real estate in these areas. If a broker can introduce clients to these opportunities, it is yet another chance to prove just how much of an asset their role can be.

Investors can put money into Qualified Opportunity Funds (QOFs) – which in turn invest in these zones – investors can then defer capital gains taxes and potentially reduce their overall tax liability. The key to maximizing these benefits for investors lies in long-term investment plans. Holding the investment for five or seven years can result in a step-up in basis, effectively excluding a portion of the deferred gain from taxation.

It's important to stress to the investor that if the investment is held for at least ten years, any gains accrued from the Opportunity Fund investment can be completely excluded from taxes. This combination of tax deferral, reduction, and exclusion not only enhances potential returns through tax savings but also allows investors to benefit from property appreciation in revitalized communities.

Contact a local tax professional

There are many more strategies that can propel your investor client to the next level, and it all starts with saving money from tax breaks. Whether it’s amount of time dedicated to investment property work or where they are looking to invest next, there are tax strategies for every type of investor out there. In order for your investor clients to take full advantage of these tax strategies and benefits, contact a local tax professional and ensure that any information provided is accurate and law abiding.