It’s tax season, and hopefully your income and investments fared well in the past year – but now you might have a big tax bill to show for it. If your investment portfolio includes real estate, however, your tax burden might not be so high. “Many of our investors don’t initially consider the potential tax benefits as part of their investment, but they definitely should,” said Chris Daugaard, a partner in Sioux Falls-based Ernst Capital Group. “Especially for investors who may be in a high tax bracket, it becomes more and more important for them to consider the tax on their investments and on their income in general.”
Ernst Capital Group allows investors to add real estate to their portfolio by investing in local and regional commercial properties, including multifamily communities. “As we talk through how our opportunities are structured, many investors aren’t aware that in addition to the other benefits of investing in real estate, there can be advantages when tax time comes around,” Daugaard said. “It’s a bigger deal for more people than they might think.” How so? Start with these three reasons.
Tax deferral through depreciation
Income tax from investment real estate is often deferred, especially at the start of the investment, with most of the tax deferred until an investment is sold. “Most of the taxable income becomes backloaded in the investment, even though it’s still a cash-flowing property for you,” Daugaard said. “This ultimately reduces your tax liability along the way.” When you own commercial real estate, you can take advantage of depreciation. This can seem a bit counterintuitive because real estate investments tend to appreciate over the long term. However, the ability to use depreciation throughout the life of the asset can count against your income, reducing your tax liability. “For instance, if you have a 10-year real estate investment, it’s not uncommon for the first few years to not have taxable income due to depreciation,” Daugaard said. “And even when you do start to have taxable income, there’s still some depreciation built up from those earlier years to offset it. Sometimes you don’t have cumulative taxable income until toward the end of a 10-year investment.”
Cash flow remains
While depreciation helps reduce your tax burden, it doesn’t impact the cash flow of the property. “You can be receiving cash flow from income generated from your real estate investment while still taking the depreciation expense. It is an expense that does not affect cash flow,” Daugaard said.
Appreciation and capital gains advantages
While real estate generally appreciates over time, that appreciation is subject to capital gains. Those long-term capital gains taxes typically are “at lower rates than what you would have paid on ordinary income otherwise,” Daugaard said. “And while you will pay some depreciation recapture, it’s usually at a rate of 25 percent or lower, which for many investors is lower than their ordinary income tax rate. However, everyone’s tax situation is different, and we encourage everyone looking to make investment decisions to discuss their individual situation with their tax adviser.” But tax advantages are just one benefit to investing in real estate – especially when you’re working with a local firm like Ernst Capital.
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The information in this article is not providing tax advice. Please consult your tax adviser for information regarding your individual situation. The information contained in this article is not an offer to sell securities. If an offering is made, it will be through a Private Placement Memorandum, which will contain details of the offering, including a discussion of risk factors. An investment decision should be made only after a careful review of the Private Placement Memorandum.
Ernst Capital is used in connection with several entities owned and controlled by Todd Ernst, Rick Martin, Nick Gates and Chris Daugaard, including Ernst Capital Group LLC, Ernst Capital Securities LLC, Ernst Capital Partners LLC and Ernst Capital Holdings LLC.