Real estate tax loopholes refer to existing tax laws, or omissions in the tax code, that give real estate investors a degree of leeway when declaring their taxable rental income.
These rules (or gaps therein), when understood and harnessed, can result in significant tax savings for a savvy real estate investor. In particular, you can position yourself to be eligible for tax advantages while simultaneously reducing your tax liabilities. You can do all this without having to attain real estate professional tax status.
We will reveal real estate loopholes you should know to set yourself up for success, as a medical professional involved in real estate.
Key Takeaways
- Understanding real estate tax loopholes offers significant tax savings for investors.
- IRS home office deductions reduce expenses for conducting real estate business from home.
- De minimis safe harbor deductions allow up to $2,500 per item in tax deductions.
- Pass-through entities and inheritance provisions offer substantial tax advantages for real estate investors.
Benefits of Understanding Real Estate Tax Loopholes
If you own real estate investments, adopting legal and tax strategies that take advantage of real estate loopholes will prove beneficial in the following ways:
- Better Cash Flow Management: Every successful real estate investor understands the importance of being cash-positive in a fluid real estate market. By leveraging current tax laws to lower your tax bill, you can have more money on hand to finance existing projects and explore other avenues for real estate wealth.
- Competitive Advantage: Real estate professionals with an understanding of the legal and tax aspects of the real estate market will have an easier time in this hypercompetitive industry. The knowledge you acquire can give you a first-mover advantage and help you make sound business decisions.
- Increased Opportunities: Many tax rules exist to encourage real estate investment by the general public. A real estate professional who understands this can take advantage of existing opportunities and eventually build a vast real estate portfolio
In summary, an understanding of the loopholes of real estate can help veteran and novice investors alike save money and set themselves up for financial success.
Table of Contents
Four Legal Loopholes Medical Professionals Can Leverage When Selling Real Estate
Whether you’re a seasoned investor or new to real estate investing, the four loopholes that follow will provide tax benefits you wouldn’t want to miss out on:
1. IRS Home Office Deductions
The IRS lets qualified taxpayers deduct expenses incurred while using a section of their homes to conduct their business. This loophole applies to homeowners and renters.
There are two criteria you must meet to qualify for these deductions:
- You must exclusively use a part of your home for conducting business regularly (e.g., a home office); and
- The home must be your principal place of business.
For this tax provision, the IRS defines a home as:
- A house. apartment. condominium. mobile home. boat or similar property; or
- Structures on the property. like a barn studio or an attached garage
Examples of expenses you can deduct when filing your taxes include mortgage interest, rent, insurance, maintenance, utilities, repairs, and depreciation.
Taking advantage of this loophole requires meticulous record-keeping and documentation of expenses. You’ll need to keep track of all business administration and property management activities performed in the course of running your real estate business from home.
Additionally, make sure to account for depreciation deductions, as they relate to the section of your home you use as an office.
2. De Minimis Safe Harbor Deductions
Section 162 of the Internal Revenue Code provides for deductions of ordinary and necessary expenses incurred while carrying on a trade or business. Examples of such expenses include repairs, maintenance, supplies, and the cost of materials.
These tangible property regulations, TPR for short, create loopholes you can exploit to reduce your tax burden.
A case in point is the de minimis safe harbor rule. This provision lets taxpayers without applicable financial statements (AFS) deduct items that cost $2,500 or less. Taxpayers who have AFS can deduct items that cost up to $5,000 or less.
The implication of this law is immense, as it applies to items on an individual basis. For instance, if you buy ten items for a rental property you’re developing for $2,500 per item, you can deduct the total money spent on the 10 items ($25,000) at the end of the tax year.
That said, de minimis safe harbor doesn’t apply to:
- “amounts paid for inventory and land”;
- rotable temporary and standby emergency spare parts you’ve capitalized and depreciated under § 1.162-3(d) of the Internal Revenue Code; or
- rotable and temporary spare parts you’ve accounted for under the optional method of accounting under § 1.162-3(e) of the IRC.
Still, this loophole is another excellent way to reduce the real estate tax payable at the end of each calendar year.
3. Pass-Through Entities
If you’re operating a real estate business side-by-side with your medical practice, you may have formed a sole proprietorship, partnership, S Corporation, or limited liability company. These legal structures are sometimes called pass-through entities and can imply significant savings in income taxes.
Unlike C corporations, pass-through entities aren’t obligated to pay income tax on their business earnings. In addition to the benefit of avoiding double taxation, a pass-through entity lets you make qualified business income deductions as provided by the Tax Cuts and Jobs Act (TCJA).
Provision 11011 Section 199A of the TCJA lets you deduct up to 20% in QBI as a business owner of a pass-through entity. It brings lower taxes at the end of a tax year.
That said, this tax advantage has limitations, as it depends on your taxable income. For example, if you’re a high earner, you may reach the phase-out threshold, precluding you from using this tax loophole.
However, this loophole is undoubtedly an excellent way to keep more money in your pocket come tax season.
4. Provisions for Inheritances
This loophole applies to inherited properties. You can use it to exempt your descendants from paying taxes on your property after you’ve passed on. It works as follows:
When your descendants inherit a property, the IRS generally views their basis in it to be either:
- The property’s fair market value on the date of your death; or
- Its fair market value on the alternate valuation date, provided that the executor of your estate has filed an estate tax return and uses the alternate valuation on the tax filing.
The IRS defines the term “basis” as it relates to property ownership to mean “the amount of your capital investment in property for tax purposes.” It’s used to calculate, among other things, any gains or losses made on the disposition of a property.
Thus, what the loophole means for anyone who inherits your property is that they can sell it without owing anything to the IRS.
Understanding the significance of this provision requires comparing your descendant’s basis in a property while you’re alive versus the moment when you die:
Suppose that, while you’re alive, you gift a property you bought many decades ago for $50,000 to a descendant. In the time between when you bought it and now, the property’s value increased to $500,000.
If your descendant decides to sell it for $500,000 they’d have to pay capital gains tax on the property’s value. In other words, they’d pay capital gains on the extra $450,000 your property gained in value on top of the original $50,000.
Thus, this property tax loophole is one of the best gifts you can give to those you leave behind.
Final Thoughts
Navigating real estate tax loopholes an intimate knowledge of existing tax laws and a willingness to stay abreast of changes. Our experts possess both qualities and can provide advice on sound strategies for keeping your taxes low.
Contact us to get a consultation on your real estate taxes and take your first step toward becoming a skilled, informed investor.
