Paying Taxes is a substantial challenge for real estate investors since the taxes siphon a significant percentage of an investor’s profits. Therefore, experienced real estate professionals have perfected the way to pay fewer taxes on their investments. Moreover, their overall investment strategy involves strategic tax planning. This article discusses how a real estate investor can pay less taxes.
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How Taxes Work
The majority of the countries, including Pakistan, utilize a progressive tax system. An advanced tax system entails that the taxable amount increases progressively as their net income increases. Moreover, a marginal tax rate is used to calculate taxes based on your taxable income. Furthermore, it is adjustable against gross income, subtracting any qualified business expenses or deductions. In addition, authorities provide particular tax incentives and deductions for entrepreneurs, physical real estate, or commodities. Therefore, take advantage of these deductions, credits, and laws, and pay less real estate taxes.
Top 5 Ways to Pay Less Taxes on Real Estate
There are various ways through which a real estate investor can pay less in taxes. This article discusses the top 5 ways.
1. Hold Properties for Over a Year
One of the simplest ways to decrease your tax burden is to hold a property for at least one year. If you’re a house flipper, you might prefer selling the selling property as soon as possible however it is more profitable to hold your properties for at least a year before selling. Moreover, the property sale is taxable as personal income instead of capital gains—which is higher in comparison. However, it’s OK to sell one short-term property per year. If a real estate investor sells two or more properties, it is classified as a “dealer” for tax purposes. Therefore, the investor incurs a higher personal income tax rate.
2. Deduct Mortgage Interest
A real estate investor can pay less taxes by deducting the mortgage interest on the property. Homeowners discount the section of their mortgages attributable to interest payments on their tax returns. Therefore, these payments are higher during the initial years of the mortgage and progressively decrease as the mortgage is paid off. Few of the tax deductions in real estate include mortgage insurance, home insurance, Property taxes, Property management fees, and more.
3. Utilize Depreciation Deduction
Properties likely depreciate due to natural deterioration and wear and tear. Therefore, a real estate investor can pay less taxes by claiming depreciation for each investment properties. Thus, the cost of income-producing rental property is recovered through annual tax deductions called depreciation. Moreover, the depreciation deduction is a reasonable allowance for deterioration, wear and tear, and obsolescence.
4. Borrow Against Home Equity
Suppose a real estate investor has acquired a lot of equity in a property. In that case, they can pull out equity from the property and utilize the funds to finance another real estate investment. At the same time, few investors decide to sell the property and use the money to finance a new acquisition. However, it incurs capital gains tax. Therefore, when a real estate investor borrows against home equity, they can still keep their property and avoid paying capital gains tax.
Moreover, also have the income to finance a new investment. The majority of the lenders will enable you to withdraw 80% to 85% of your home equity. However, this is risk involved since an investor loses equity in the property and incurs more debt. A good strategy is to rent out the property to a tenant and use the rental income to pay off the borrowed property equity.
5. Keep Track of Every Expense
It’s challenging to develop a tax strategy without keeping track of all real estate expenses. Therefore, as a real estate investor, it is crucial to maintain thorough records of all costs, especially if you wish to claim tax deductions. Moreover, there are various real estate apps, and property management software’s that assist in maintaining a track of expenses and even help prepare for your annual tax filing. Therefore, to pay less taxes, ensure to add one or two of these apps to the real estate investment toolbox.
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Real estate investor can increase their real estate profits by learning how to pay less in taxes. Estate Land recommends utilizing the above five best ways to reduce taxable amounts. Moreover, consistency and patience are a requirement for long-term real estate success.