No matter how hard we work, it’s still difficult to minimize your taxes and keep more income for yourself. Like all income, real estate investment income is taxed too. However, different types of real estate income are treated differently in the U.S. tax system.
How are rental properties taxed?
Well, we know from our previous article that rental income is taxed as ordinary income. Though, it should be noted that you are allowed to deduct expenses associated with the upkeep and maintenance of the rental property. In the end, the taxable amount should not be equal to the total amount of your rental income. Instead, it should represent your net income – the amount you earned minus the costs required to earn it. You may as well do what you can to lower your amount of taxable income.
How are capital gains taxed?
Capital gains can occur on a variety of real estate investment strategies. Whether it’s a buy and hold, a rental property or even a fix and flip, hopefully you realize some capital gains. Basically, any property that you purchase at some point before selling it at a later date could be subject to capital appreciation. Well, hopefully it’s gains and not losses – though we will discuss both. In the case of capital gains, these are usually taxed at around 50% of the typical income tax rate. However with capital losses, you are typically able to write-off the full amount.
How are REIT proceeds taxed?
The dividends you receive from holding a REIT are typically taxed as ordinary income tax rates – unless they are qualified dividends. In the case of qualified dividends, they will be taxed at the capital gains rate. A qualified dividend must meet three criteria in order to be eligible:
Paid by an American company, or a qualified foreign one
Dividends are not listed with IRS as ‘not qualified’
Required dividend holding period is met – Investors must hold the shares for a set number of time before they can benefit from a lowered tax rate.
If each of these three conditions are met, then you have yourself a qualified dividend and are subject to the capital gains tax rate. Otherwise if you’re not so lucky, then your dividends will be taxed as the ordinary rate. But don’t worry because most REIT dividends will be taxed at an ordinary rate. However, you may recall from our article about REITs that the REIT itself receives a tax advantage, which you indirectly benefit from. Specifically, if the REIT pays more than 90% of its earnings out in dividends than it receives a tax break. So although your dividends may be taxed higher when you receive them, at least they received a break before that.
How is earned interest taxed?
Again, any interest you may earn on your real estate investments is usually taxed as the ordinary income tax rate. This applies to any interest you collect on your real estate investments too. If you’re wondering when you could be collecting interest on your real estate investments, consider the case of a seller financing agreement. In this case, you also collect interest on the monthly principal payments.
So as you can see, the best tax treatment applies to capital gains and qualified dividends. If you want to be keeping more of your income in your pocket, leverage these as much as you can in your real estate investing efforts. Today's market is filled with many opportunities for the savvy investor. Our Elite Legacy Education trainers will introduce you to proven strategies that can help you launch your career as a successful real estate investor.
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