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When it comes to using real estate tax credits to boost investment returns, rookie real estate investors may be leaving money on the table.
Here’s how investors at every level can use tax credit programs to maximize profits.
What are real estate tax credits?
Real estate tax credits are incentives provided by governments and municipalities to encourage investment in certain types of real estate projects. These might include:
- Historic preservation
- Affordable housing
- Renewable energy
- Locating a business in certain areas
- Investment in opportunity zones
Some of these programs offer help with low-interest mortgages, closing costs, and out-of-state investors looking to relocate a business. Others reduce taxes or eliminate them altogether for a period of time.
In addition to reducing tax liabilities, real estate tax credits can also enhance the overall profitability of the investment by increasing the value of the property. For instance, historic preservation tax credits can help developers restore and preserve historic buildings, which can significantly enhance their value and appeal to potential tenants or buyers. This increase in value is an important safeguard against inflation and other market fluctuations.
Similarly, renewable energy tax credits can help developers install energy-efficient systems that reduce operating costs and make the property more attractive to environmentally conscious tenants or buyers.
By taking advantage of these credits, investors can not only reduce their tax burden but also enhance the overall profitability of their investments.
How to use real estate tax credits
Real estate tax credits are a great incentive that can bring investment dollars into neighborhoods that desperately need a boost. Here are four steps to get you started.
Step 1: Identify qualifying projects
To use real estate tax credits effectively, you need to first identify the types of projects that qualify for these incentives. For instance, the federal government offers tax credits for developers who renovate historic buildings, install solar panels, or build low-income housing.
State and local governments may also offer similar tax incentives for certain types of real estate investments. By researching these programs and understanding the requirements for eligibility, investors can determine which projects offer the most favorable tax benefits.
Step 2: Gather your team
Once you have identified eligible projects, consider partnering with experienced developers and contractors who have a proven track record of success with these types of investments.
Developers who specialize in historic preservation, affordable housing, or renewable energy projects are likely to be well-versed in the various tax credit programs available and can provide valuable guidance on how to structure the investment to maximize the tax benefits. They can help you navigate the complexities of the application process and ensure that all necessary documentation is submitted on time.
Experienced developers and general contractors also tend to have a wide network of service providers and suppliers. This can come in handy when supply chain issues arise or permits are stuck in a back office somewhere.
Step 3: Pay attention to the clock
The next step to maximizing real estate tax credits is the timing of the investment. Many tax credit programs have strict deadlines for when projects must be completed in order to qualify for incentives. Poorly timed investments could mean missing out on tax credit eligibility.
Investors should work closely with their developers and tax advisors to ensure that they are meeting all applicable deadlines and are taking full advantage of the tax benefits available.
Step 4: Mind your money
Just as few new homeowners understand the unexpected costs of homeownership, new investors might not properly estimate how much it costs to take on a rehab or restoration project. Adding to this is the fact that some tax credits require investment minimums on the part of the investor — above and beyond the initial purchase.
Keep an eye on the bottom line, tracking projected versus actual expenses and adjusting your budget as needed. This can prevent heartache at tax time.
Beyond real estate tax credits
Real estate tax credits provided by local, state, and federal governments are just one way that investors can maximize their profits. If you’re new to investing, it’s best to consult with a tax professional to make sure you are getting the most out of your properties. They will analyze your expenses and make sure you are getting all the credits you can, including:
- Passive income and pass-through deductions
- 1031 exchange tax breaks
- Long-term vs. short-term capital gains
- Depreciation of rental properties
- Tax-deferred retirement investment accounts
Itemized deductions are one of the best ways to reduce your tax burden. Some deductible expenses include:
- Mortgage interest
- Property taxes
- Advertising rental properties
- Paying a property manager
- Petty repairs like fixing leaks or painting between tenants
Many of these require receipts and proof of the expense. Talk to a tax professional to verify what is eligible for both state and federal taxes, too. Some expenses that aren’t eligible for a federal deduction qualify to lower your state tax bill.
Restrictions on tax credits
Everyone has a different situation, and there are restrictions on tax credits. For example, moving expenses used to be deductible but are no longer allowed for anyone except the U.S. military until 2025.
And if you are thinking of adding a structure to your property and deducting the cost of that material, think again. Capital improvements to a property, including additions, are not usually tax deductible.
Don’t miss out on real estate tax credits
Real estate tax credits can be a valuable tool for investors looking to boost their returns. By identifying eligible projects, partnering with experienced developers, and timing the investment appropriately, investors can take advantage of these incentives to reduce their tax burden and enhance the overall profitability of their investments.
As always, investors should consult with their tax advisors and other experts to ensure that they are fully compliant with all applicable regulations and are making the most informed investment decisions possible. This can help you make the most of your investment and reduce your tax burden — now and years into the future.
Luke Babich is the CSO of Clever Real Estate in St. Louis. Connect with him on Facebook or Twitter.