12 Tax Savings Buying Investment Property in the Ann Arbor Area
The government wants investors to provide housing and create jobs so incentivizes that behavior with tax benefits.
Disclaimer- No part of this was written a third party or a robot. We are not tax experts, this is for information purposes only, and each person’s situation is unique so always consult a tax professional before making any investment or tax planning decisions.
12 Ways Investors Save on Their Taxes Buying Ann Arbor Area Investment Property
To consider the ways investors can save on their taxes, let’s look at the options. This list is not all encompassing but rather a survey of some common and less commonly known tax strategies and benefits.
1. All Rentals and Income Property- All income property can benefit from deductions related to property management and business operations. Also, investors can depreciate the property's useful life using the IRS schedule reducing taxes. Finally, refinancing the property to pull out equity is also tax free.
2. Long-Term Rentals- Income from long term rentals is considered “passive income” as you do not have to actively work on it like a job which is taxed differently than active income. Capital gain taxes are reduced for owning the property for a year or more before selling.
3. Short-Term Rentals- Income from short-term rentals can be considered active income if the average stays are 7 days or less and the owner can document 500 hours of “material participation” managing the rental. Then, the short-term rental can offset active W-2, 1099, or other business income.
4. Real Estate Professional Status (REPS)- This is where an individual or a married couple can work together with enough hours every year to show material participation. Also, one spouse or individual must show a minimum number of hours working on the business a year (750 hours) and spend more than 50% of their working time on the real estate business. Once REPS status is met per the IRS guidelines, then the entire portfolio of real estate, including both active and passive investments, are considered active investments and can reduce other active or business income.
5. Owning the Building You Do Business- In the grouping election under Section 469 of the Internal Revenue Code, it allows you to group your business with the building into a single activity. You would want to hold the business and the building in separate LLCs which allows you to offset active income from your business if the building expenses are greater than the rent paid to the LLC of the building.
6. 1031 Exchange- This allows you to defer the taxes on real estate sales if you buy a property of equal for greater value than you sold.
7. Cost Segregation- This is a process where you study the property and break it into its component parts accelerating the depreciation or useful life of those parts reducing income tax and increasing the real cash flow. This can be done on a single-family rental up to an apartment complex and office building. You can accelerate the depreciation for certain parts of the property taking the tax benefit sooner than the 27.5 years for residential properties and 39 years for commercial properties—the number of years the IRS considers their useful life.
8. Bonus Depreciation- Also known as first-year depreciation, allows extra depreciation in the first year and is 40% in 2025 and goes down to 20% in 2026 and phases out in 2027 if the law is not renewed.
9. Opportunity Zones- If you invest in an income property in an opportunity zone and own it for five years you will receive a 10% step-up in basis (what is used as your purchase price and to calculate capital gains taxes when you sell) and a 15% bonus for owning for seven years. You can eliminate capital gains taxes completely if you invest for at least 10 years in an opportunity zone.
10. Self-Directed IRA- These are more complex to set up than a traditional IRA but you can own real estate and other assets like physical gold and silver in a tax advantaged way to save for your retirement.
11. Delaware Statutory Trust Exit Strategy- Is one way to minimize and spread out the capital gains over time if an investor is tired of directly owning real estate and would like to keep the passive income and also be able to pass it on to heirs rather than sell it outright and take the capital gains hit all at once when they sell.
12. Charitable Remainder Trust Exit Strategy- This is another way to minimize or spread out capital gains taxes over time when an investor is ready to be done directly owning real estate. It is irrevocable and creates a tax deductible donation in the year it is transferred, the trust pays you or another beneficiary for a number of years (gift taxes may apply for non-spouses), and at the end of the trust’s term the remaining assets go to one or more charities.
Let’s look at four of the strategies more closely and certainly you can contact us and our tax professional partners for more information about any of these strategies or about buying investment property in the Ann Arbor area.
Why Buying Short-Term Rentals in the Ann Arbor Area May be Great for Reducing Your Taxes
Most real estate is considered a passive investment which limits how much you can deduct from active W-2, 1099, or business income.
However, if the average stays are less than 7 days and you document materially participate in managing the property with more than 500 hours in the year per the IRS, then you can offset your active income.
This is a huge tax benefit for any income earner but especially high income earners.
This, coupled with bonus depreciation and accelerated depreciation form a cost segregation study, can greatly reduce the amount of tax you pay for your active income. Short-term rentals are loaded with items that can be cost segregated and depreciated faster like furniture, fixtures, decks, pools, hot tubs, and specialized landscaping.
Building a portfolio of short-term rentals, buying one every year or two, can be an effective way to reduce your income tax while you are working.
In short, short-term rentals are a great way to not only create cashflow but reduce your active income taxes significantly.
“The government wants investors to provide housing and create jobs so incentivizes that behavior with tax benefits.”
Why Bonus Depreciation and a Cost Segregation Study Can Save You on Taxes Investing In Any Ann Arbor Area Investment Property
Bonus depreciation allows you to accelerate a percent of the purchase in the first year (sunsets in 2027 unless the law is renewed) and cost segregation is a way to accelerate the depreciation or useful life of those parts of the property faster.
1. Bonus Depreciation Tax Savings- One can accelerate depreciation 40% in the year of purchase in 2025, 20% in 2026, and phases out in 2027 unless renewed.
2. Cost Segregation Tax Savings- It is breaking down the property into it’s component parts and accelerating depreciation on the parts that don’t need to follow the 27.5 year schedule for residential and 39 year schedule for commercial.
Components that must follow the 27.5 year schedule are things like the foundation, roof, and walls. The parts that can be accelerated are things like appliances, parking lots, and landscaping.
The Cost Segregation Process:
Step 1-Comprehensive Property Review and Detailed scope.
Step 2-Conducting an Engineering Analysis Of Every Component
Step 3-Asset Classification for Tax Benefits
Step 4-Generating the Cost Segregation Report
Step 5-Filing for Tax Deductions with Cost Segregation
Common property types that benefit:
Single-Family Rental Cost Segregation Study- Yes, even a single-family rental can qualify cost segregation benefits and because it is less complex it costs less ($800-$1,500) to do an engineering backed modeling study. As long as the tax savings are greater than the cost of the study, it may make financial sense depending on your goals.
Multifamily Property Cost Segregation Study- While the cost of doing a full detailed engineering study ($3,000-$10,000) on a multifamily property is more, there are more components that qualify for accelerated depreciation like pools, gyms, and quality interior features and the tax savings likely will be more than the cost of the study.
Short-Term Rental Cost Segregation Study- This property class really benefits from this tax strategy because it is loaded with things that can be depreciated faster like outdoor lighting, swimming pools, hot tubs, big decks, furniture, fixtures, elaborate landscaping, and other amenities. While the cost of the cost segregation study likely will be more because of the complexity, the tax savings will be much greater. Finally, there are many components with a lifespan of less than 20 years which qualifies for bonus depreciation in the first year.
Bonus depreciation and cost segregation studies are two powerful ways to save money on your income taxes and in the case of short-term rentals potentially your active income.
How Working With Your Spouse to Get Your Real Estate Professional Status Can Reduce Your Income Taxes Using All Your Ann Arbor Area Investment Property
If you are interested in turning your entire portfolio of real estate, including the passive income properties like long-term rentals, into properties that can offset your active income or business income then one can work with their spouse to meet the Real Estate Professional Status or REPS as detailed by the IRS.
What is involved?
The IRS requires the following to qualify:
Time Commitments-
1. 50% Rule- One spouse, or individual, must work more than half of their working hours, every year, on real estate related activities.
2. 750 Hours Rule- While you and your spouse can work together to meet the 500 hours of material participation rule in your real estate business, one person must also meet the 750 hour rule to qualify for Real Estate Professional Status. It is wise to get extra documented hours as the IRS may disallow some of the hours in the total.
While getting the Real Estate Professional Status may not be for everyone, it can be extremely beneficial to high income earners to offset their active W-2 or business income.
Why Owning the Building Your Business or Professional Practice is in Can Save You Money on Your Taxes
This strategy is another way to offset active income, business income, medical practice income, or professional practice income by owning the building where you do business or practice.
Under Section 469 of the Internal Revenue Code, one can group the business or practice with the building as a single activity.
Here is how it works:
1. Separate Entities- One would want to have one entity (LLC) for the building and a separate entity (LLC) for their business or practice.
2. Rental Income- The business or practice entity would pay rent to the LLC that owns the building.
3. Expenses and Depreciation- The building would have normal expenses like mortgage payments, utilities, property taxes, maintenance, insurance, and depreciation to offset the active income from the business or practice. A cost segregation study can also be done on a commercial building as well to accelerate the depreciation.
4. Paper Loses- If the total expenses, including depreciation, are greater than the rental income, the LLC for the building will generate a loss to offset the active income from the business or practice.
Owning the building where you do business or conduct your professional practice is another way to offset active income taxes.
Bottom Line, You Can Save Money on Your Taxes Investing in Ann Arbor Area Real Estate
There are so many ways to save money on your taxes when you buy, own, and when you are ready to slow down and exit your real estate investing career.
Four strategies we see commonly are:
Short-Term Rentals offsetting the active income or business incomes for the investor.
Bonus depreciation and cost segregation studies accelerating the useful life or depreciation of components allowing for greater tax benefits now.
Individuals working with their spouse to get Real Estate Professional Status or REPS turning their entire portfolio of properties into active income offsetting their W-2, 1099, or business income.
Owning the building where you do business or practice professionally can offset the income from the business or practice.
In short, the government wants investors to provide housing and jobs and incentivizes that behavior with tax benefits.
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