5 Real Estate Tax Strategies to Enhance Your Legacy

Recently, I attended a conference of over 150+ Registered Investment Advisors (RIAs) in Scottsdale, AZ, where there was a discussion of the power of tax advantaged real estate investments and given the pain some readers may feel while writing large checks to the IRS, I thought this may be an opportune time for a reminder on the powerful tax benefits of real estate.

The US tax code is written to incentivize certain behavior such as investments in a particular sector, or providing housing, which by some estimates is 4 million units short of what is needed today (with no immediate change on the horizon).

Real Estate Tax Benefits

 
Many wealth managers and investment advisors love the tax benefits their High Net Worth clients and Family Office clients get from real estate investments, particularly multifamily:

1. Accelerated Depreciation and Bonus Depreciation – At Penn Capital, we conduct a Cost Segregation Study on our portfolio properties that essentially deconstructs each floor plan into its individual components (e.g. flooring, countertops, appliances, electrical fixtures, etc) which allows our accountants to depreciate it in as little as 5-7 years vs the typical 27.5 year of “straight-line” depreciation for multifamily buildings. This often creates a “paper loss” that offsets or shelters the income generated by the property, that would typically be taxed at a higher rate. This depreciation benefit is passed on to the investor-partners on the K1. This “tax loss” can also be used against other passive income. When the asset is sold, there is depreciation recapture but that is capped at a lower rate than the typical income for a high-income earner, based on current IRS rates.
2. Use of Qualified Retirement Funds – Due to the gigantic marketing budgets of brokers and mass media, not everyone is aware that they can invest their retirement funds in alternative assets not correlated to the stock market (like real estate) through a self-directed retirement account such as a SD-IRA, SD-Roth IRA or Solo 401k. This allows your investment to grow and compound at a much higher rate over time.
3. 1031 Exchange – One of the most powerful sections of the tax code is Section 1031 aka “Like kind exchange of real property” that allows you to sell and exchange one investment property for another while continuing to defer the capital gains, thus allowing your investment to grow faster. One benefit, if it can be called that, is when the owner of that property passes away, the owner’s heirs will get a stepped-up basis that could eliminate the deferred capital gains.
4. Qualified Opportunity Zones - This investment opportunity was created through the 2017 Tax Cuts and Jobs Act, encouraging economic development in defined low-income areas or zones. One can defer eligible capital gain tax (from a variety of sources) by investing in a QOZ through a qualified opportunity fund (QOF). This program allows a step-down in the capital gain taxes at defined intervals until all of it is wiped out after 10 years.
5. Installment Sales – This strategy allows you to spread out the capital gains over time and is typically used to manage your income tax bracket for the given year.

Savvy investors can use a combination of the strategies above and leverage the legal tax incentives provided by the US government to grow their generational wealth and leave behind a larger legacy.