Tax Strategies for Real Estate Investors to Maximize Profits

(Disclaimer: The content of this article is not intended as financial or investment advice but rather information for educational purposes only.)

This article is based on the episode of the Building Equity podcast “Tax Strategies For Real Estate Investors” with BJ Cottrell from Cottrell Tax & Accounting LLC in Naples, Florida. Click here to watch the episode.

For individuals who are just starting their career in real estate investing, being proactive by speaking with a tax accountant initially can help ensure their record keeping is accurate and that they aren’t overpaying in some facets. Whether it is investing in an active rental property or a passive REIT (Real Estate Investment Trust), these types of investments are structured differently from a tax perspective than publicly traded stock, so it’s imperative investors get informed about the tax strategy that is best for their investment type to protect profits.

A new investor in the market could save thousands of dollars by hiring an accountant up front to overlook the proper tax planning strategy and help mitigate potential long-term losses.

Choosing the Right Tax Strategy for Your Real Estate Investment

Determining the best tax strategy for a real estate investor depends on the investment type. An experienced tax accountant would first need to understand the investor’s objective to advise accordingly. Common questions your tax accountant would want to know are:

1. What is the time frame for holding the property? This provides insight on potential capital gains and depreciation for deductions. Holding onto a property for at least a year can help mitigate taxes.

2. Is this a short-term rental or long-term rental? This prepares an investor for other taxes besides federal. For example, in the state of Florida, short term rentals (six months or less) must pay sales tax, which is 6%. The second tax that will have to be paid the tourist tax, which can be around 6-7%. Preparing for these taxes allows an investor to incorporate fees into the monthly invoice for their tenant, allocating funds for the investor to fulfill payments come tax time.

3. Is this a fix and flip? For investors who are engaging in fix and flips, their tax accountant will want to portray their real estate ventures as purely investments to alleviate Social Security and Medicare taxes and reap the benefits from the capital gains rates, depending on which bracket the investor falls under. If the IRS detects that an investor is engaging in fix and flips as a full-time venture, A.K.A “dealing,” investors can be hit with ordinary income tax as well as self-employment tax. To avoid being categorized as a “dealer,” it is recommended for an investor to have a job on a W2 and to never have more than one fix and flip property occurring at a time.

Whether an investor is buying and holding a property lot for a few years or owning several properties at a time, when it comes to the IRS, it’s recommended for an investor to be taxed at an individual level and pass-through to the personal tax return because of capital gains rates. Investors can take up to $25,000 of losses from a rental property to offset ordinary income on a personal tax return, which can’t be done with other passive investments because passive losses can only be offset by passive gains.

Another key factor when it comes to tax strategies is whether a business entity is involved. Whether it is an LLC, partnership, a corporation, or INC, each legal structure has a different designation on how they are taxed by the IRS. Most tax professionals and attorneys advocate for the LLCs because they’re more flexible and can be taxed as a single member LLC, which is disregarded if there’s two or more members; the default is to be a partnership, which is a pass-through entity. An S-corporation is also a pass-through entity as well, meaning the business does not pay income tax of its own; its income, losses, credits, and deductions all “pass-through” to each business owner’s personal tax return, where profits are taxed according to each owner’s individual income tax rate, giving investors the best tax treatment.

Make Depreciation Work in Your Tax Favor

One of the smartest ways real estate investors can keep more money in their pockets during tax time is taking advantage of depreciation. It’s common amongst hesitant investors when they hear about potential losses associated with depreciation to be discouraged about real estate investing all together. Understanding how to benefit from these referenced “losses” is how investors can get bigger deductions and maximize profits.

To fully grasp the concept of depreciation and how it can work for investors when it comes to taxes, let’s look at a hypothetical example:

– An investor buys a rental property for $275,000.

– The IRS requires the investor to depreciate the property every year for up to 27.5 years, which means every year, the investor takes a $10,000 deduction in depreciation.

– This depreciation goes on the investor’s tax return as an expense, reducing the basis. This allows the investor to write off $10,000 to offset rental income or even ordinary income from a W2 job because it is passing through to the individual tax return.

– Looking at the same investment in the long-term, if this same investor keeps this rental property for the next seven years, taking a $10,000 loss each year, and then goes to sell the property for $400,000, instead of a $125,000 gain, because the investor took $70,000 in expenses that went to ordinary income on the tax return, the investor will now have a $195,000 gain.

This example of depreciation shows how an investor with a rental property theoretically takes a loss on paper but capitalizes on cash flowing and building equity on the property. Because the intricacies of real estate can be extremely complex, to ensure you’re following the best tax strategy, it is critical to consult with a licensed tax accountant for proper guidance.

Pro Investor Tips for Bigger Tax Benefits

For investors looking to truly maximize deductions on their real estate properties each year, there are several recommendations to ensure optimal tax treatment:

Set Up a Business Entity- Creating a business entity for holding your real estate not only provides asset protection and limits liabilities but also lets investors run their rental properties like businesses, keeping personal and business funds separately. Whether it is a single member or a husband-and-wife single member LLC, or even a partnership depending on the circumstances, an investor forming an LLC receives an EIN number (a social security-type number for the business) and can open a separate bank account for the business. Having a separate account for the real estate business is crucial for investors because they can avoid comingling payments and expenses for tax purposes while also minimizing personal liability if a suit is ever filed against the LLC. It is also suggested to utilize this bank account or a single credit card for all property-related payments and expenses for complete transparency.

Investors who are looking to fix and flip multiple properties are strongly encouraged to set up an S-Corp (S corporation) to place all their real estate properties under. This type of business structure offers several tax benefits for investors, allowing them to write off all their expenses (cell phones, cars, computers, home interest, etc.). And while investors will be subjected to an ordinary tax rate as well as Social Security and Medicaid at a 15% self-employment tax, an S-Corp entity allows investors to pay themselves a salary while drastically reducing the amount of self-employment tax they will have to pay.

Save Receipts- Expenses related to properties add up over the course of the year, and if investors aren’t saving receipts or tracking their spending, they could miss opportunities for deductions on their taxes. The IRS will need to see verifiable proof of a business expense to claim a deduction, so saving receipts is vital.

Get Organized- Managing a real estate operation requires an organized system to run smoothly. Because running a real estate venture like a business is multi-faceted, investors need to keep track of their records, bookkeeping, expenses, and other documentation as efficiently as possible, especially when it comes time to extract this data for tax purposes. Software such a QuickBooks or even a simple Excel spreadsheet is highly recommended to ensure all your pertinent information is stored and easily legible.

Staying organized with your operation is essential, especially if the goal is to scale your rental business. Ambitious investors who are looking to expand their operations are highly encouraged to consult with a licensed tax accountant who can sign and assist with creating an official P&L (Profit and Loss Statement), which is a requirement if an investor wants to obtain a loan from a bank for further real estate ventures.

Partner with the Pros for Your Next Real Estate Transaction

Investors looking to close on a real estate property are encouraged to check out IRA Title Pro, a full-service title company that focuses exclusively on IRA real estate closings. Enjoy faster closing times and an experienced closing team that also understands fractional IRA interest in the property.

Why Creating a Business Entity is Crucial for Real Estate Investing

(Disclaimer: The content of this article is not intended as financial or investment advice but rather information for educational purposes only.)

This article is based on the episode of the Building Equity podcast “ Creating The Right Business Entity for Real Estate Investing” with Mr. Jeffrey Grant, a real estate attorney from the law firm of Grant, Cottrell & Miller-Myers in Naples, Florida. Click here to watch the episode.

Investing in stocks and bonds has always been considered the smarter, more prudent strategy for generating long-term profits while real estate was always stigmatized as the riskier venture for investors. But over the past few years, the industry has seen a momentous shift in investment approaches. Whether it is global impact or common market volatility, stocks and bonds are shaping up as the more precarious investment strategy.

While individuals are seeing drastic fluctuations in their retirement portfolios when it comes to stocks and bonds, reporting as high as 10% returns to as low as 20% losses, investors holding real estate are experiencing consistent positive returns with no impact from outside influences. As uncertain times continue to surround the markets, real estate has emerged as the more shrewd, beneficial investment strategy, yielding bigger, more steady returns with less risk.

Protect Your Real Estate Investment with a Business Entity

While investing in real estate is clearly becoming the smarter strategy, investors looking to purchase properties in their names should strongly consider against it. From succession planning to asset protection, investors are encouraged to explore a business entity for real estate to keep their investments protected. Let’s look at a few ways investors could make themselves susceptible to liability without a business entity, putting personal assets in jeopardy:

1. Injuries sustained by tenants or guests- If a tenant or guest(s) of your tenant experiences an injury or accident on your property, you could be subjected to a lawsuit for compensation.

2. Hiring unlicensed contractors- If your tenant hires an unlicensed contractor to make repairs to your property, it could cost you more money for repairs to be done correctly or other fines and fees, especially if an accident/injury occurs due to the improper work completed.

3. Dispute with tenants- If a dispute occurs between you and your tenant(s) over the condition of your property, the lease, or an eviction, without a business entity in place, you could be responsible for fees associated with settling these disputes.

Placing your property in an LLC (Limited Liability Corporation) is the perfect, most cost-effective solution to protect your real estate investment. This type of business entity ensures that investors (company owners or members) are not personally liable for the debts and liabilities of the entity, offering a much-needed layer of protection from these hypothetical situations. Forming an LLC allows investors to separate their personal and business assets and liability as well as obtain an operating agreement.

An operating agreement lets investors open a bank account for their LLC, which they can use to deposit their received rent payments, eliminating the possibility of comingling funds while creating an official business operation for their rental property. Investors who operate their real estate investment under an LLC can manage their properties more professionally and effectively with an aura of anonymity, implementing office policies for late payments and other stipulations they set forth.

Not Hiring a Licensed Real Estate Attorney Could Cost You

It’s common for first time investors to commit oversights when it comes to forming an LLC on their own. Whether it’s skipping out on hiring an attorney to ensure the LLC is created correctly or failing to open a bank account in the name of the LLC and comingling payments, when investors try to cut corners, it can cost them financially. Many investors may believe hiring an attorney for creating an LLC is too costly, but that’s a misconception. Without an expert attorney, investors could lose their asset protection all together, even if they completed some of the steps successfully, resulting in significant losses and liabilities.

For example: If a tenant gets sick on one of the properties owned by an LLC due to mold growth, but the property owner functioned as the handy man for repairs, the bookkeeper, and accepted checks under a personal name, a lawsuit could be brought against the property owner personally, sidestepping the LLC due to improper practices.

Another common mistake investors make who form an LLC on their own is failing to conduct the annual filing. This can result in the state dissolving the business entity altogether, making all signed contracts void, and any filed lawsuits go against the individual property owner. If this is the case, all the assets that the property owner has, whether it’s additional properties, bank accounts, wages, and more, if a judgement is entered against the individual, all assets are in jeopardy. If a lawsuit is brought against an LLC and the LLC was formed correctly, then only the assets owned by the entity would be at risk, not the assets owned by the individual who owns the LLC.

Other complications derived from an improper filing of an LLC arise when attempting to sell the property. While it’s much easier for an investor to purchase a property when first forming an LLC without using a licensed attorney, it becomes much more cumbersome when it’s time to sell the same property and steps were missed. Common issues occur when a title company needs to verify who has the right to sign on behalf of the entity, especially if there are multiple people listed on the LLC. This major dilemma can prevent investors from unloading their properties and is extremely costly to fix.

LLC rules and regulations vary state by state, not by federal laws, so it’s critical to consult with an attorney based on this fact alone. For individuals looking to invest in real estate, the smartest thing investors can do to protect their investments and assets is to hire a licensed real estate attorney to form an LLC for their property(ies).

Choosing the Best Business Entity for Your Real Estate Investment

Not all real estate investors will have the same objectives for their properties, which is why it’s important to understand which business structure is best for your type of investment. From fix and flip to buy and hold, not all real estate ventures are the same, nor are the recommended entities for holding your properties.

For a fix and flip scenario which will see a lot of people through a short-term basis with the goal of unloading the property, it’s recommended to hold all these type of investments under one LLC. For individuals looking to buy and hold properties, it’s suggested to hold each property under a separate business entity, aka series LLC, where the holding company owns the buy and hold properties and the fix and flips LLCs.

Fix and flips should be looked at differently from an investment perspective and set up differently than a buy and hold from a tax perspective as well, which is why speaking with a licensed real estate attorney is the smartest thing an investor can do.

Prepare for Your Family’s Future with Succession Planning

It’s imperative for investors who hold real estate in their LLC to be proactive with their properties to ensure a smooth transfer upon death. Oftentimes, when someone who owns real estate passes away, even if that individual has a will, there will still be probate. To avoid the onerous probate process, it’s suggested to set up a revocable trust (living trust) in which all assets are titled, making the distribution of assets simple.

To avoid filing fees and deeding of properties, individuals who own multiple properties in an LLC can set up a revocable trust so that when they pass away, the membership interest is easily transferred without probate. This type of careful planning can make a difficult time for your family a bit easier, especially when it comes to distributing assets accordingly and mitigating disputes.

Partner with the Pros for Your Next Real Estate Transaction

If you’re searching for a knowledgeable, highly recommended licensed real estate attorney in the Naples, Florida area, contact Jeffrey Grant of Grant, Cottrell & Miller-Myers at (239) 649-4848.

Investors looking to close on a real estate property are encouraged to check out IRA Title Pro, a full-service title company that focuses exclusively on IRA real estate closings. Enjoy faster closing times and an experienced closing team that also understands fractional IRA interest in the property. Find out more at