If you’re looking for lucrative avenues to invest your money in, try the real estate industry. You can build houses and rent them out for income. Additionally, you can sell your properties after some time. If you maintain them properly, they can even become more valuable over time. Thus, you’ll end up bagging more money than what you initially spent on the purchase of the properties. 

However, to reap the maximum returns from your investment, you should familiarize yourself with the rules of the industry, determine the projects and strategies that’ll bring you more income, and identify the ones that will empty your pockets. Taxes, for instance, have a way of slashing your total income to shocking levels if they’re not properly managed. They might leave you with losses on an investment you thought would be profitable.

On this account, this article discusses several strategies you may implement to ensure that you pay the government its dues as efficiently as possible, hence, achieving the most of your property investment. Read on to learn more:

1. Apply The 1031 Exchange

The 1031 exchange derives its name from section 1031 of the Internal Revenue Code. If you’re a property owner, it allows you to postpone paying your taxes for an unspecified amount of time. This arrangement, however, is on the condition that you buy a similar property with the profits incurred from your first property investment.

A 1031 exchange scenario may work like this: you buy a house worth USD$200,000 and spend an additional USD$50,000 on improvement and maintenance. Afterward, you sell it for USD$ 300,000. Therefore, you’ve earned a profit of USD$ 50,000.

Now, you may choose to spend this profit on a new set of furniture or jewelry and get taxed for them. Alternatively, you could defer your taxes for some time with 1031 exchange services. For this, you need to invest the profits on a similar house project. For instance, you can use the profits as a down payment for another house. You won’t be taxed for this, thus, you’ll save yourself a significant amount of money. 


2. Use Seller Financing

Simply put, seller financing is where you handle the mortgage process of the buyer. Instead of them using traditional financial institutions, they’ll pay you directly in installments.

So, when paying for income tax from the sale, you’ll only pay a percentage of the down payment from the buyer, and you can complete the remainder over time with every payment the buyer makes. 

However, this can be risky, particularly in the event that the buyer defaults in their payment. Therefore, you have to thoroughly vet the buyer before agreeing to enter into an installment sale. You can do this through a lease-purchase agreement, where the buyer will first start by renting the house, with part of their rent proceeding to a down payment for the house. When a certain deposit amount is reached, you can transfer full ownership of the property to the tenant and close the deal with a mortgage note.
 

3.  Own Properties For Longer Than A Year

If you plan on buying properties and selling them for a profit later on—otherwise known as flipping—it’s recommended that you do so after at least a year after the purchase. That’s because by flipping your properties within a year of purchase, the government will tax you at your normal income tax rate. The Internal Revenue Service (IRS) may even classify you as a self-employed dealer, and you’ll end up paying double the tax rates.

On the other hand, if you own the properties for more than a year, you’ll be taxed based on capital gains, which have rates that are way lower than income tax rates. However, if you have to flip the properties, you can rent them out for a year or more before selling them. This way, you won’t only decrease your tax rates but you’ll also get extra income from the leasing.

4. Maximize Your Deductions

One of the many plus sides of property investment is its extensible room for tax deductions, especially if you’re renting out your house. Some notable ductions include the following: 

• Insurance: Deductible areas may include theft, fire, flood, or landlord liability insurance. If you have employees, their health and workers’ compensation insurance can also add to the deductions.
• Interest: These include mortgage interest payments on loans used to buy or renovate your property. It could also be interest from goods and services used in rental activities.
• Travel: You’re entitled to a tax deduction of your travel expenses associated with your rental activities. For instance, you can list down the gas money and all other travel expenses you use when you go to a hardware store to buy equipment to repair a tenant’s house.
• Legal fees: As long as the fees are paid for work related to your rental activity, you can deduct them from services from your attorneys, accountants, property investment advisors, and other expert service providers.

These are just some of the deductions you can claim to minimize your tax bills. To learn more about these deductions, you can speak to your accountant.

5. Steer Clear Of Double FICA Taxes

These are taxes designed for Medicare and social security. Combined with local, state, and federal taxes, FICA taxes sum up to a tax rate of 15.3%. If you’re employed, your employer shares half of the taxes. However, if you’re self-employed, you’ll be responsible for the whole 15.3%.

Therefore, as mentioned earlier, if you flip property in the same year of buying, IRS may classify you as a self-employed dealer. 

To avoid the FICA taxes, you could state in your records that property sale isn’t among your regular business practices. Rather, it’s a means for you to generate capital for other investments, such as paying to renovate other assets or making a deposit for a rental investment property.

6. Borrow, Don’t Sell

Over time, your property appreciates. You may choose to sell it, but you’ll have to pay for property gain taxes. Alternatively, you can rent it out and borrow money against it so you won’t have to pay any taxes. 

This way, you can pay the loan back over time from the rental income from your tenants. And you’ll get to keep the property, which will continue appreciating if under proper maintenance.

7. Depreciate Your Property Values

The IRS set the lifespan of a residential building to 27.5 years. Therefore, you can deduct 1/27.5 of your total tax for the construction projects in your property every year for the first 27.5 years. You can also apply this to individual capital improvements on your building, for instance, on repair and maintenance costs such as installing new roofs, railings, or windows on your building.

8. Utilize The 20% Pass-Through Deduction

This deduction plan was incorporated into the Tax Cuts and Jobs Act of 2017. It applies to small business owners, including property investors. With this, you’ll be able to deduct an extra 20% from your net business income. 

However, the process may seem slightly baffling, especially if you lack sufficient experience in handling taxes. For this reason, you should consider hiring an accountant who’ll help clarify what’s involved in this process.

9. Use A Self-Directed IRA

Individual Retirement Accounts (IRAs) are retirement plans that postpone tax payments for their users. Therefore, they’re an efficient way to invest for retirement. With that in mind, you can set up your own self-directed IRA, which you’ll use as a tax-free method for your property investment.

However, the process is a bit complex. To begin with, you’re required to hire a custodian to oversee the self-directed IRA processes for you. They’ll create the self-directed IRA where you’ll be transferring your money. You can then create a liability company to buy and own the investment properties. The self-directed IRA will then invest money into the limited company.

However, before setting up a self-directed IRA, ensure to conduct thorough research on the process it entails and hire reliable custodians.

10. Own Your Properties To The End

This strategy will be more beneficial to your heirs. If you pass away maintaining ownership of your property, you can go away with the acquisition cost and your heirs won’t have to pay capital gains.

Thus, try to lease the property and keep pocketing the rent. If you need some more cash, you can borrow against the property instead of selling it, as explained above. When you pass away, your inheritors get to own or sell the property tax-free as they won’t be required to pay capital gains.

Conclusion

Property investment is a strategic way to utilize your money. However, it can be expensive, especially if taxes aren’t carefully managed. This article has highlighted ten methods you can use to ensure you comply with the government’s tax-paying system while paying the least amount of tax. 

These strategies include1031 exchange services, selling your property in installments, owning the property for more than a year, avoiding double FICA taxes, setting up a self-directed IRA, borrowing money instead of selling your property, maximizing your deductions, and for the sake of your estate, owning your property throughout your life.

If you utilize these tax-efficient tips, you’ll surely be a step ahead at increasing your savings, investing even more on other properties, and becoming more profitable.