James Kandasamy of Austin, Texas is a best-selling author, real estate developer, and investor of multi-family properties. In the following article, James Kandasamy discusses the tax advantages of investing in multi-unit properties.
Benjamin Franklin hit the nail on the head when he said, “in this world, nothing can be said to be certain except death and taxes.” However, that doesn’t mean multi-family real estate investors need to worry about them or pay more than what’s necessary. There are quite a few tricks to minimize one’s tax obligation. According to industry experts, those who research them end up generating higher returns than those who don’t.
From cost segregation to the 1031 exchange to the passive income tax benefits to depreciation tax, there’s a whole world of cost-reducing methods out there for multi-family real estate investors to discover.
James Kandasamy Discusses Real Estate Tax Deductions
Every investor should understand the costs they’re legally allowed to deduct, especially in the multi-family investing landscape where it can save so much money.
James Kandasamy of Austin, Texas says that the law allows expenses incurred from maintenance, repairs, and management to be deducted from an investor’s total taxable rental income. Specifically, this includes:
- Mortgage interest
- Insurance premiums
- Management costs (e.g., software and personnel)
- All maintenance and repair expenses (e.g., labor and materials)
- Marketing expenses
By decreasing their total taxable rental income, individuals significantly reduce their tax burdens.
Passive Income Tax Benefits
James Kandasamy of Austin, Texas says that in the context of taxes, passive income includes money earned through limited partnerships, rental properties, and other businesses wherein the person doesn’t actively participate. The rate at which the Internal Revenue Service (IRS) calculates passive income tax is lower than regular income tax rates.
The specific rate, however, depends on whether the passive income is considered long-term or short-term. The latter is taxed at the marginal income tax rate, whereas the former is taxed from 0% to 20% based on the investor’s marital status, filing status, and yearly taxable income.
Only multi-family real estate investors can take advantage of this passive income tax benefit. It doesn’t apply to real estate professionals who take an active role in the buying/selling process.
Real Estate Depreciation Tax
James Kandasamy of Austin, Texas explains that depreciation is perhaps the best real estate tax advantage available for rental investors.
It revolves around the principle that properties depreciate as time goes on. Thus, this amount of depreciation is a tax deduction that covers the building’s wear and tear throughout the years.
James Kandasamy of Austin, Texas says that on the surface, this may seem impossible. After all, property values increase over time, so how can the building itself decline?
Well, the IRS treat residences like most other asset types. So, a residence’s quality diminishes progressively in the Service’s mind — similar to owning a car.
The government considers residential properties’ useful, profitable lives to be over after 27.5 years. Thus, investors can deduct the depreciation expense using that timeframe for reference.
To calculate the amount, they must divide its worth by the number of years (i.e., 27.5). So, a $600,000 home would have a yearly depreciation expense of $21,818.18.
James Kandasamy of Austin, Texas notes that this depreciation (which is often never realized in the real estate world anyway) offers huge tax breaks. Investors are able to deduct the depreciation expense whether their property is turning a profit or appreciating. Savings galore.
Cost segregation, an advanced technique, takes the aforementioned depreciation tax benefit and (potentially) accelerates it beyond the straight-line depreciation for 27.5 years.
James Kandasamy of Austin, Texas says that an engineer or expert consultant will conduct a cost segregation analysis, a study that aims to inspect every aspect of the property and separate all physical assets into the following four categories:
- Personal property
- Land improvements
- Land size
The professional then uses these classifications to accelerate the depreciation over a smaller window of time. For instance, personal property can be depreciated for 7 years, while improvement depreciations can be depreciated over 15 years.
James Kandasamy of Austin, Texas asks, what is the net result? The allowable depreciation amount in a single year is substantially boosted for extra tax savings.
The 1031 Exchange
James Kandasamy of Austin, Texas notes that large tax bills tend to occur upon a sale. The difference between the building’s cost and the sale price is called capital gain, which is taxed at a 15% to 28% rate.
However, the Internal Revenue Code lets owners defer capital gains taxes on profit-making sales by reinvesting the money into another similar building. Additionally, there is no limit on the number of times investors can do this, letting their income grow tax-free for long periods.