Real estate is generally a great long-term investment. However, as with any investment, there are potential pitfalls that need to be considered. One is to make sure you have adequate plans to deal with the complex web of property tax regulations. The tips we share here will help you make smarter decisions about your property tax strategies to maximize your returns.
What taxes do property owners need to pay?
There are various taxes and fees that property owners may be required to pay. Some apply to all owners and some only apply in limited circumstances.
1. Property tax
Any property you own within the county is subject to real estate taxes payable to the local county government. Your precise property tax bill is calculated based on a formula based on your property’s assessed value and local tax rates, and is typically paid twice a year.
2. Capital gains tax
When you sell property for a profit, you must pay tax on the profit. This is a capital gains tax.
3. Income tax
If your property is used to generate recurring income (such as rentals), you must pay income tax.
Key Strategies for Managing Property Taxes on Long-Term Real Estate Holdings
Real estate holdings tend to experience significant appreciation in value over time, allowing investors to passively earn income and grow wealth. However, if you are not strategic in managing your property taxes, your potential gains can be severely eroded. Here are six tried, tested, and proven strategies that can give you an edge.
1. Strategically manage your property’s assessed value
Property taxes can be high, especially if your property or neighborhood has experienced significant appreciation. It’s important to note that your property’s appraised value may sometimes be higher than its true value. This means your property tax bill will be unfairly high.
In this case, you can initiate a property tax appeal. Be sure to request a copy of your property appraisal from your local property assessor’s office so you can double-check what they relied on in making the appraisal.
Additionally, keep in mind that certain upgrades, such as energy-efficient fixtures, can increase the value of your property without significantly increasing your tax bill. Be sure to find out what specific tax incentives your local government may offer for property improvements.
2. Take advantage of the homestead exemption
If you own property that is used primarily as a personal residence, this is generally considered a homestead. While you can’t use homestead exemptions on investment properties, you can generally use them to reduce property taxes on a residence.
The specifics of the homestead exemption vary by state. To determine which provisions you are eligible for, check with your local tax office. However, in almost all cases, be prepared to provide evidence that the property is being used as your residence.
3. Investment Company Structure
If you own multiple properties, you will not be able to claim the homestead exemption on all of them. Instead, you might consider investing in a corporate structure such as a limited liability company (LLC), which will formally hold your property in its name.
There are many potential benefits to doing this, but two of the biggest are the ability to defer income taxes on rental income and the ability to apply depreciation based on the appraised value of the property.
Additionally, you may consider investing in a real estate investment trust (REIT) as an alternative to buying and holding real estate yourself. REITs can sometimes allow owners to benefit from pass-through taxes and reduced tax obligations.
However, REITs are governed by strict laws, which present potential pitfalls for inexperienced owners. This guide explains what REITs are and how to use them for real estate investing.
4. Seek professional tax advice
When planning your real estate investment strategy, we strongly recommend that you consult with a qualified tax professional, such as a Certified Public Accountant (CPA) or a tax attorney. These professionals often have deep experience, professional networks and modern legal artificial intelligence (AI) tools. Tax mistakes can be costly and should be avoided by seeking assistance as early as possible.
5. Apply for tax-deferred exchange (1031 exchange)
If you are buying or selling a home primarily for investment purposes, consider protecting your income through a 1031 exchange. A 1031 exchange is an exemption that allows you to defer capital gains taxes when you sell a property if you immediately invest the proceeds in another similar property.
Important warning: 1031 exchanges can be complex, so it is wise to consult an attorney or accountant for detailed guidance.
6. Explore property tax exemptions
Some states and counties offer property tax abatements or exemptions that allow you to pay no taxes at all or significantly reduce your tax bill. Be sure to contact your local government to ask if there are any such regulations.
Start investing in real estate for the long term
It’s always a good idea to invest in real estate as a long-term investment strategy. With these tips, you should know how to get started and how to build your investment safely.
Notes on BiggerPockets: These are the opinions written by the author and do not necessarily represent the views of BiggerPockets.
