Real estate is typically an excellent choice for long-term investment. However, as with any investment, there are potential pitfalls to consider. One is ensuring you make adequate plans to handle the complex web of property tax regulations. The tips we’ll share here will help you make smarter decisions about your property tax strategies to maximize your returns.
What Taxes Do Property Owners Have to Pay?
A number of taxes may apply to property owners. Some apply to all property owners, and some apply only in limited cases.
1. Real property tax
Real property taxes are paid to your local county authority on any property you own in the county. Your precise property tax bill is calculated on the basis of a formula that factors in the assessed value of your property and the local tax rate, and will usually be paid twice a year.
2. Capital gains tax
When you sell a property for profit, you must pay a tax on the profit. This is capital gains tax.
3. Income tax
You must pay income tax if your property is used to generate recurring income, such as rent.
Key Strategies for Managing Property Taxes for Long-Term Real Estate Holdings
Over time, real estate holdings tend to experience dramatic gains in value, allowing investors to earn income and grow their wealth passively. If you’re not strategic about managing property tax, however, this can see your potential gains significantly eroded. Here are six tried, tested, and proven tactics to give you an advantage.
1. Manage your property’s assessed value strategically
Property taxes can be significant, particularly if your property or neighborhood has experienced a significant appreciation in value. The thing to note is that the assessed value of your property may sometimes be higher than its true value. This would mean that your property tax bill would be unfairly high.
In such cases, you can initiate a property tax appeal. Be sure to request copies of your property assessment from your local property assessor’s office so you can scrutinize the data they’ve relied upon in making their assessment.
Additionally, remember that certain upgrades, like energy-efficient installations, can increase your property value without significantly boosting your tax bill. Be sure to find out what specific property improvement tax incentives your local government may offer.
2. Leverage homestead exemptions
If you own a property that you primarily use as your personal residence, this is generally considered a homestead. While you won’t be able to use homestead exemptions for investment properties, you can generally use them to reduce property taxes on your residence.
Homestead exemptions vary in their specifics by state. To be sure what provisions may be available to you, check with your local tax office. In almost all cases, however, be prepared to offer evidence that the property is used as your residence.
3. Invest in a corporate structure
If you own multiple properties, you won’t be able to claim homestead exemptions on all of them. Instead, you may consider investing in a corporate structure such as a limited liability company (LLC), which would officially hold your property in its name.
There are numerous potential benefits to doing this, but the biggest two are the ability to defer income tax from rental income and the ability to apply depreciation against the assessed value of your property.
Additionally, you may consider investing in real estate investment trusts (REITs) as an alternative to buying and holding property on your own. REITs sometimes allow property owners to benefit from pass-through taxation and reduced tax liabilities.
However, REITs are governed by strict laws that create potential pitfalls for inexperienced property owners. This guide is a look at what REITs are and how they can be used in your real estate investing.
4. Seeking professional tax advice
In planning your property investment strategy, we’d strongly advise consulting with a qualified tax professional, like a certified public accountant (CPA) or tax attorney. These professionals typically have a wealth of experience, access to professional networks, and modern legal artificial intelligence (AI) tools. Tax mistakes can be costly and should be avoided by seeking help early.
5. Apply for tax-deferred exchanges (1031 exchanges)
If you’re primarily buying and selling homes for investment purposes, consider protecting your earnings through 1031 exchanges. A 1031 exchange is an exemption that allows you to defer capital gains taxes when you sell a property if you immediately invest the gains in another, similar property.
An important caveat: 1031 exchanges can be complex, so it would be wise to speak to a lawyer or accountant for detailed guidance.
6. Explore property tax abatements and exemptions
Some states and counties offer property tax abatements or exemptions that allow you to pay no tax at all or pay dramatically lower taxes. Be sure to reach out to your local government to inquire about the availability of any such provisions.
Getting Started With Long-Term Real Estate Investment Holding
Investing in real estate as a long-term investment strategy is always a great idea. With these tips, you should have a good idea of how to get started and how to structure your investment safely.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
