Top San Francisco Real Estate Tax & Property Tax Strategies for 2018
Two things are certain in life: death and taxes. But savvy taxpayers understand itâ€™s less about if you pay taxes, and more about how you pay your taxes.
As youâ€™ll soon learn, the IRS is actually at its friendliest when dealing with real estate owners and investors. If you donâ€™t already have your money in property, youâ€™ll consider it by the end of this article.
Below youâ€™ll find the top 5 real-estate tax and property tax benefits in 2018, with a handy punchline if you only have time for a quick skim:
1 â€” No self-employment tax
Punchline: Real-estate investors are not classified as self-employed, despite the fact they donâ€™t have bosses.
At a basic level, real estate investors are self-employed. They donâ€™t have bosses setting deadlines, and they make money by the sweat of their brow (figuratively speaking). The IRS doesnâ€™t see it that way, however. Income received from renting out properties is not classified as â€œearned incomeâ€, and as such avoids the burden of self-employment tax.
2 â€” 1031 Exchanges
Punchline: 1031 exchanges let you use profits from one property sale to buy another property without paying a dime in tax.
Section 1031 of the IRS tax code established an exchange (now referred to as a 1031) that clever real estate investors use to major advantage. Basically a 1031 exchange allows investors to sell a property and use the profits to buy a new, more expensive property â€” all without paying a dime in taxes. (Although the properties need to of â€œlike-kindâ€: you canâ€™t sell an office building and buy a swanky condo in SF.) However, if you do wanâ€™t to buy a condo, check out our buildings to see if thereâ€™s one that suits your tastes.
Of course, investors will have to pay the IRS if they want to put money in their pocket, and not another property. But the 1031 defers that pay-out. That means investors can climb their way up the property investment ladder, and only cough up to Uncle Sam once they reach the top. San Francisco property and real estate taxes are already high and a 1031 is a clever way to reduce the tax burden.
3 â€” Deductions
Punchline: Double-up living expenses with real-estate expenses to save money with deductions.
Renting out property is expensive. You have to cover the cost of insurance, repairs, homeowners association fees, and miscellaneous expenses that inevitably pop up out of nowhere. Luckily, Uncle Sam allows you to deduct nearly every one of these expenses â€” from water bills down to the pens you sign your contracts with.
True, you still have to spend the money to earn the deduction.
But the real benefit kicks in when real-estate expenses overlap with living and other work expenses.
Say you own a home office, which you use in part to manage your rentals and in part for Mommy blogging. Now say your office takes up 10% of your homeâ€™s square feet. Because the home office is used partially for real-estate purposes, you can deduct 10% your total home expenses. Thatâ€™s 10% of your cell phone bill, 10% of your mortgage interest, 10% of home repairs, etc.
Or say you need to fly from California to New York to check on the state of your rental property â€” and that your mother happens to live in New York as well. You can deduct the cost of the flight, and surprise Mom at the same time. Weâ€™re not advocating any funny business (your tourist trip to the Statue of Liberty is NOT a real-estate expense), but a clever property owner can figure out ways to double-up expenses without bending the law.
4 â€” Depreciation
Punchline: The IRS says your house will collapse in 27.5 years (which it wonâ€™t), and allows you to deduct it as a depreciating asset.
A depreciation is just a special type of deduction â€” but itâ€™s so special it deserves its own sub-heading.
Say youâ€™re a small business owner who just bought a swanky office chair for $250. The IRS will allow you to deduct that $250 as a business expense, but not in the year you bought it.
In the same way the Greek Fates decided the lifespan of every human, the IRS decides the lifespan of every asset. Revisiting the example above, the IRS says that your office chair will last 10 years. Therefore that you must deduct its cost over the course of 10 years, not the single year you purchased it in.
What does this mean for Real Estate?
The IRS has determined the life of a piece of residential property is 27.5 years, and commercial real estate 39 years (donâ€™t ask us how). That means residential and commercial real estate owners can deduct the value of their property over 27.5 and 39 years respectively.
This may sound like a bad thing, but itâ€™s actually good. The IRS is wrong about real estate. Houses donâ€™t collapse in 27.5 years â€” in fact, their value usually goes up. That means real estate owners are deducting a loss that simply isnâ€™t happening.
5 â€” Long-Term Term Capital Gains
Punchline: Hold on to property for longer than a year to qualify for long-term capital gains: a more favorable tax structure.
The most basic definition of capital gains is the profit you make when you sell a property. And like every other time you put money in your pocket, the IRS wants a cut.
They take that cut in two ways: short-term capital gains and long-term capital gains. The two terms sound similar, but have dramatically different tax implications.
Short-term capital gains are defined as profits made while holding the investment for under a year; long-term capital gains: profit made while holding the investment for longer than a year. Long-term gains are, generally speaking, more favorable to taxpayers.
Thatâ€™s because short-term capital gains are not treated differently from any other profit. Youâ€™ll be taxed at whatever IRS bracket your income places you in.
Long-term capital gains tax, on the other hand, is capped at 20% â€” and can go as low as 0% for married couples filing jointly.
Long term capital gains is one of the major reasons people drive income from renting real-estate, vs. more traditional streams. Make money without breaking a sweat AND pay next to nothing in taxes? Yes, please.
So there you have it. It takes a bit of money to get on the property ladder, but once youâ€™ve got a foothold there are plenty of ways to work with Uncle Sam.
Weâ€™re not saying youâ€™ll get a warm glow in your stomach every time someone mentions the IRS, but as a real estate owner/ investor you are eligible for far more benefits than your unpropertied brethren. Check out our SF apartment buyers page to see where you can get started.
And finally, a mandatory disclaimer: the US tax code is longer than War and Peace, with a lot more footnotes. Before moving forward on any tax strategy â€” including the ones recommended above â€” set up a meeting with an accredited CPA.