Tax Benefits That Come From Investing in Real Estate

Investing in real estate can produce robust returns and has several tax benefits, making it an attractive addition to any retirement portfolio. By utilizing the process of amortization and depreciation, the value of a real estate investment asset can be calculated in different ways. It is a careful balancing act, but the benefits are worth the effort.

When applied to real estate, amortization is the gradual repayment of a loan, including a schedule for interest and principal payments until the entire amount is paid off. When a property is purchased, it is rarely paid for in full upfront, but that does not make real estate a less viable option for investment portfolios. This is because amortization can become a tax deduction that can recoup your capital costs over time. Because amortization applies to intangible assets, the actual property cannot be amortized; it can only be depreciated. When initially purchased, the loan itself and the acquisition costs cannot be amortized, but when a property is refinanced, it is counted as a new expense – almost as though improvements have been made to the property – allowing the mortgage to be amortized.

In contrast, depreciation applies to tangible assets – such as physical property. A property’s value constantly fluctuates, with changes in the housing market providing some of that change. It is said that when a car is driven off the lot, it depreciates. A house depreciates and appreciates value for a variety of reasons. Standard wear and tear of a property being lived in can cause its value to decrease even as the housing market causes its value to increase. Currently, you can take the depreciation deduction for the entire expected life of a property, which the IRS estimates is 27.5 years for residential properties and 39 years for commercial properties. Dividing that amount of time by the total cost of the property equates to the amount that can be written off on that year’s taxes. Once a property is sold, it is important to remember that there is a requirement (depreciation recapture) that the standard income tax rate applies to the depreciation claimed unless a 1031 exchange has been utilized.

Several tax write-offs are connected to real estate investments, as many of the costs associated with real estate ownership can be written off. Property taxes, property insurance, mortgage insurance, property management fees, and maintenance fees can all be deducted directly. Certain businesses can also write off expenses, including advertising, office space, business equipment, travel expenses, and legal and accounting fees. Therefore, the prospective value of an investment asset can only be determined by its investor – whether by actively increasing or decreasing its value.

At its core, real estate investments are a long game. Even if the goal is a quick purchase, renovation, and then flip a property to garner additional capital, it is rare for an investor to complete the process only once. After all, the central benefit of real property as an investment asset is its value and how it is calculated.