Basic Principles for Real Estate Investment
To be a successful real estate investor you will have to follow some basic principles. These are to ensure that you are making a well-thought through step forwards and that the activity will bring you a considerable profit. As professional tax planning advisors with keen interest and experience in the real estate investment, we would like to present this mini guide to you.
Estimating Cash Flow from a Real Estate Investment
It is important to calculate the potential cash flow from your investment before you make it. To do this you will have to estimate the expected income from the real estate you’ve invested in and then find the present value of the expected income. You need to understand that your income can come from two main sources:
Annual income from the operation of the investment
Gains on the disposition of the real estate (sale)
An equity investor will be looking at the after-tax cash flows generated from any of the above sources. And this is where proper understanding of taxation becomes crucial.
Taxing Profits from a Real Estate Investment
For income from operation, there are two sources of tax:
Ordinary income tax
Minimum tax on preference income from operation
To get an accurate due tax figure, the real estate investor has to estimate their taxable income and the marginal tax rate for each year of operation.
For income from sales, there are three sources of tax:
Capital gains tax
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Classifying of a Real Estate Investment for Tax Purposes
Real estate investments are classified into four categories for tax purposes. These are properties held for:
Sale to customers
Use in business and trade
Generally, most real estate investments, under the tax code are seen as held for use in business or trade, rather than investment.
It’s important to classify your real estate because this way you can control the tax influence on your investment. Here’s an example. If you bought a property for personal residence, then any living costs and maintenance expenses will not be deductible. You will also be unable to deduct a depreciation allowance. If you sold that property and incurred a loss, then you won’t be able to deduct it, but if you made a profit on the sale, then that would be taxed either as short or long-term capital gain. All these deductions would be available if your real estate is classified as held for use in business or trade, or for investment.
Tax Shelters for Real Estate Investments
We often talk about tax planning because its primary aim is to minimize the amount of tax you pay, therefore maximizing your wealth. In real estate investments you can take advantage of these three tax shelters (even though some limitations apply):
Conversion of ordinary income into capital gain at the time of sale
It is essential to build a smart and sustainable tax planning strategy when you are investing in real estate. This will ensure that the value of your investment is as high as possible. Do you know how to use these tax shelters to your advantage? FAS CPA & Consultants can help you craft the right tax plan for your investment activity.
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