A Comprehensive List of Handy Tips to Decrease Tax Exposure and Save Money
Wealth management means thinking strategically, and while the goal of every investor is to generate capital, this is primarily achieved in two ways: by increasing income and limiting tax liability. One of the most effective methods of limiting tax liability is to invest in real estate, as many tax laws are deliberately set up to encourage real estate ownership. Armed with this knowledge, a savvy real estate investor can save thousands annually on their tax bill, so long as their affairs are managed correctly. Here is a comprehensive list of ten tax benefits and strategies to help real estate investors decrease tax exposure and save money, according to entrepreneurial investor, Jeff Cooley.
Hire a Tax Strategist
Retaining the services of a tax strategist or a real estate-focused certified public accountant can result in the immediate savings of a significant amount of money. These professionals are well-versed in the complicated realm of real estate taxation, and know the best strategies to ethically re-position an investor’s holdings in order to limit exposure.
Invest Directly
Instead of investing indirectly through a brokerage or company, consider investing directly in real estate. It carries with it certain advantages, chief among them is the issuance of a K-1 form. In reporting income on a K-1 rather than the usual tax form, an investor can maximize their deductions which will result in a much lower tax liability.
Take Advantage of Cost Segregation
Cost segregation is a tax planning strategy used to speed up the depreciation of certain components of properties. Whereas the depreciation of properties on the whole is tied to fixed, straight-line life cycle (commercial property is a 39 year cycle and residential property is a 27.5 year cycle), improvements such as parking lots, new floors, cabinets, and some appliances can be classified and assessed separately, almost always in the investor’s favor. It is another effective way of shoring up deductions.
Correctly Classify Deductible Expenses
Far too often real estate investors miss out on opportunities to reduce their taxation due to improper classification of deductible expenses. It may be the inclination of an ordinary accountant or bookkeeper to simply capitalize all expenses of a real estate investor, not realizing that many of them can be written off all in the same year. With this in mind, an investor’s careful review and appropriate alteration of their deductions can pay off in a big way.
Return Capital
Instead of distributing income, a real estate investor ought to consider returning capital to themselves and their other investors, states Cooley. Return of capital has no effect on taxes, and if timed correctly, can result in a significant increase in deductions.
Refinance and Reinvest
Just like any ordinary homeowner, an adroit real estate investor has the option of refinancing their properties to obtain a lower interest rate, or otherwise negotiate more beneficial terms. Once again, timing is important to keep in mind, but if the markets and interest rates are favorable, this can potentially save a lot of money—especially if multiple properties are involved. If the proceeds from refinancing are then channeled into other investments, they will not be taxed.
Use the 1031 Exchange
So named because of its inclusion in section 1031 of the IRS tax code, the full exploitation of the 1031 exchange is one of the more intelligent tax strategies at a real estate investor’s disposal. Simply put, if an investor wishes to sell a property, any applicable capital gains taxes can be deferred by invoking this exchange so long as a ‘like-kind’ of property is purchased with its proceeds. Although navigating through the 1031 exchange can be fairly complicated, it is worth noting that the IRS’ definition of a ‘like-kind’ of property is fairly loose.
Become a Qualified Real Estate Professional
If enough time is spent on real estate related activities (roughly half of the working hours in a year, or more than 750 hours), an investor may be eligible to become a qualified real estate professional. The major benefit to earning this title is the ability to maximize any passive losses in the current calendar year rather than carrying them forward, as most passive real estate investors are required to do.
Capitalize on Retirement Options
By maximizing contributions to self-directed IRAs, self-directed Roth IRAs, solo 401(k)s, and—depending on whether it makes sense for the individual—whole life insurance policies, an investor can not only consolidate funds for retirement, but also gain tax-free income in the present.
Reset Basis at Death
Finally, after years and decades of deferring taxes on real estate sales and acquisitions, the best strategy for a real estate investor to employ in order to dodge capital gains taxes is to reset basis at death. Essentially, this means passing on any real estate to legal heirs at death rather than selling it beforehand for cash or other liquidity. By doing so, an investor’s heirs may be able to reset the basis of these properties and avoid a hefty tax bill. This is an excellent strategy to preserve family wealth and pass it down through generations.
In Toledo, there is a saying: it is better to keep money in the family than to let the government take it. By following these ten tax benefits and strategies, any shrewd real estate investor will put themselves in a much better position to do exactly that.
Jeff Cooley is veteran businessman and entrepreneurial investor with more than thirty years of accumulated executive-level experience in the private sector. A graduate of Central Michigan University, he spent the early portion of his career in education before making a change and following his passion for business—what would ultimately be his life’s calling.
Jeff Cooley began his business career as a marketing strategist for La-Z-Boy Incorporated, but soon left to take a position on the senior marketing team at Calphalon, a noted and successful kitchenware concern. There, he quickly rose the ranks, being promoted to president and CEO of the company in 1990—a position he would hold until 1998, when Calphalon was acquired by Rubbermaid. After the merger, Jeff emerged as the global president of Rubbermaid’s kitchenware division.
These days, although technically retired, Jeff Cooley spends his time working as an entrepreneurial advisor to several small companies. Additionally, he is the owner of several Limited Liability Corporations, as well as the president of the Toledo, Ohio based firm MLMC. He resides in Toledo to this very day.
