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Tax Season, the worst time of the year for every American from every corner of life. As you submit those files to Uncle Sam, you wonder how much more he’ll make you pay. It doesn’t have to be this way and with the right tools, you can [legally] reduce the amount you pay in taxes every year.

Learn More About Self-Directed Individual Retirement Account (SDIRA)

How Do I Get Started?

The Income tax rate on the middle class continues to increase while wages are down and the cost of living in many areas is extremely high. The wealthy know how to legally avoid paying too much in taxes and get a bad wrap for it. But what if there was a way you could also finesse the tax system and reduce your tax baggage? First, you should use a Self-Directed Individual Retirement Account (SDIRA) for your investments. A SDIRA is one of the many Defined-Contribution Retirement plans that are offered today. The SDIRA’s main benefits are that it is tax deferred (meaning that any investments made through your SDIRA grow tax free until the point of withdrawal) and it allows you to make investments in assets other than stocks, bonds, and funds (which a traditional retirement account does not allow). Second, use your SDIRA to invest in real estate. Investing in real estate comes with a plethora of tax benefits, which is key to reducing your tax liability and sending Uncle Sam packing.

What Makes Real Estate Such A Hot Asset To Invest In?

Real Estate as an investment has been around for a long time. The Wealthy used real estate as an investment to diversify their portfolios and offset any potential risk they could incur from the stock market’s volatility. Real Estate’s sheer illiquidity allows the investor to benefit if the real estate market skyrockets. However, in times of a real estate market crash, the investor suffers immensely as well. It is with this high risk, that investing in real estate can prove to be highly rewarding and with the right portfolio management, the potential risks that real estate investing incurs–can be offset.

What Advantages Does The SDIRA Have In Investing In Real Estate?

Owning Real Estate is what the Wealthy have done for years to pay as little as possible in taxes. Given the political discourse over the wealthy allegedly not paying their ‘fair share’ in taxes; it is important to note what exactly the wealthy do to pay little in taxes every year. The wealthy love to invest in real estate because of the amount of [legal] tax advantages they can get. Adding real estate to your SDIRA portfolio will bless you with the same ‘wealthy friendly’ tax advantages to reduce your tax liabilities as well. Using your SDIRA to invest in real estate has certain tax advantages namely: 

  1.  Deductions-You can deduct certain expenses related to your real estate properties such as property tax, maintenance, mortgage interest, depreciation, and more .
  2. Tax Deferment– Using your SDIRA, you benefit from tax deferred income. While after every profit, a regular real estate investor has to foot the bill for Uncle Sam; using your SDIRA allows you to defer on all tax payments so long as you invest using your SDIRA and never withdraw any money from it. Combine that with the tax benefits real estate investing in general offers and you could potentially pay less in capital gains and any other taxes to Uncle Sam.  
  3. Opportunity Zones– The Tax Cuts and Jobs Act (2017) incentivized investors to invest more in financially neglected areas such as rural towns and inner-city neighborhoods. These roughly 9,000 areas spanning the length and width of the country are referred to as ‘opportunity zones’. Investing in an opportunity zone comes with it, an insane tax deduction on your capital gains. To qualify for a deduction of up to 15% on your capital gains, you must hold your property in the designated opportunity zone for 7 years. Investing in opportunity zones comes with other insane perks that you should definitely not pass up on.

Pass-Through Deduction– Passive Income is any money that an investor receives with no labor involved. With the passing of the Tax Cuts and Jobs Act (2017),  rental property investors can deduct up to 20% of the net income received. However, it is important to note that this deduction is only possible if your property is profitable. This deduction is scheduled to expire in 2025. 

What Are Some Disadvantages to Investing in Real Estate using a SDIRA?

You (hopefully) now know the ins and outs of taxes and investing to reduce your tax liabilities. However, I’d be pulling your leg if I didn’t tell you Uncle Sam wouldn’t be too thrilled about you trying to run away from him. The IRS maintains strict guidelines on how you make use of your real estate properties through your SDIRA and even a slight accidental deviation can result in your account being disqualified, paying up heavy penalties in addition to paying up a whole lot of taxes that the SDIRA allowed you to defer on. 

Some the “Do Not Even Dare To Attempt To Break” rules that the IRS mandate include: 

  1. All Transactions and Expenses are to be done under your SDIRA and not your personal accounts or credit.
  2. You are Prohibited from engaging in any kind of investment transactions with “Prohibited Persons”-such as your immediate family and extended relatives.
  3. You cannot use property for personal uses- Such as living within the property or renting out to a relative (relates to “prohibited persons).

There are many ways to significantly reduce your tax liability in a legal manner. Using an SDIRA to invest in real estate is a very accessible and navigable way you can take to achieve a reduction in your tax liability. This is by no means an exhaustive guide and as always, do your proper research to stay up to date with current market conditions and tax regulations.

References:

https://www.moneycrashers.com/lower-taxes-real-estate-investor/

https://www.fool.com/millionacres/real-estate-investing/rental-properties/buying-rental-properties-self-directed-ira/#:~:text=Buying%20Rental%20Properties%20With%20a%20Self%2DDirected%20IRA&text=As%20long%20as%20the%20IRS,can%20own%20in%20a%20SDIRA.

https://www.fool.com/millionacres/taxes/real-estate-tax-deductions/top-5-tax-advantages-real-estate-investing/

https://news.yahoo.com/guide-self-directed-iras-140801945.html?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAAJTAVzEStPlBaNDtHMPzFN_xzjnYF2q2axTf34B1rN_LWdZNN6d1Awa8U0eRjDTeYwQJHsvYbCfi4nF9MP_whJoZ-yx58MydD_zYL58_yZrSP-2-lvZYbjqOrSHdjQjnSW52EuiwlwrwAwQA451Bc1d8qQKqYKlhDmPgH7V–jq3

https://www.forbes.com/sites/forbesbusinesscouncil/2021/05/24/exploring-the-tax-benefits-of-real-estate-investing/?sh=6fb8933053ff

https://www.iraresources.com/blog/why-self-directed-ira-real-estate-investors-llc

https://www.cbre.us/research-and-reports/opportunity-zones/opportunity-zones-guide

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Avatar Anikait Konatalapalli

Author: Anikait Konatalapalli

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