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Real Estate Investments and Tax Implications: The Complete Guide

There are several reasons you should invest in real estate. It’s the most effective way of diversifying your investment portfolio. The values of the properties you own will increase over a long period of time. During this period, you can even earn extra passive income by renting out your properties. But, how will your real estate investments be taxed?

Before getting into the world of real estate, potential investors must consider various tax implications. Generally, investing in real estate comes with various tax benefits. For instance, every year, property owners can write off certain expenses on properties that generate income.

However, like all things related to taxation – the tax implications of real estate investing are complex. Here are the key details potential real estate investors need to consider.

What Types of Taxes are Real Estate Investments Subject To?

When investing in real estate, whether you’re a property owner or an investor, you’ll be subjected to various different taxes. For instance, property owners who rent out their homes or condos have to pay property taxes to their state/local governments. They also have to pay income taxes on the rental revenues their properties generate.

Conversely, people who invest in real estate without the trouble of actually owning properties are subjected to individual income taxes. If you invest via a real estate investment trust (REIT) or via crowdfunding – you’ll only have to pay income taxes. Here are the different types of taxes real estate investors and property owners typically have to pay –

Property Taxes

State and local governments impose these taxes on property owners. These taxes are based on the properties’ current values. Property tax rates vary in different locations. Currently, Belgium makes property owners pay 11.3% property tax – the highest in the world. Most international investors tend to steer clear of such countries with super-high property taxes.

Instead, they focus on areas where property taxes are very low. That’s why Hawaii attracts so many American and foreign property investors. The state has the lowest property tax rate in the USA. The local property tax rate is the first factor investors should consider before entering any real estate market.

Real Estate Income Tax

The income you produce by renting out your real estate properties is taxed as normal income. Different taxation bodies have different rules regarding real estate income taxes. For e.g., in the US, real estate investors have to take a material participation test. This test helps determine whether their real estate income should be taxed as regular income.

Net Investment Income Tax (NIIT)

If your real estate investments yield interest, dividends, and other investment incomes, you’ll have to pay Net Investment Income Tax. NIIT only applies when your real estate investments generate more than a specific amount of income. This amount varies in different countries. In the US, the IRS applies 3.8% NIIT on net real estate investment income.

Capital Gains

If you sell a house/property for more than what it cost initially, you’ll have to pay capital gains tax. This tax applies to all capital investments – stocks, intellectual properties, etc. Here’s how you can calculate your capital gains –

  • Assess the initial cost of the property (the price you paid originally for the property).
  • Add any other expenses you had to undertake to secure and maintain the property. These expenses include – acquisition fees, real estate agent’s commission, and expenses on upgrading the home.
  • Now, assess the selling price of your property. Subtract the total property costs from the selling price. That amount is your overall capital gains in this transaction.

The rate of taxation on capital gains varies in different parts of the world. Typically, most governments classify capital gains into two categories – short and long-term. Short-term capital gains are the incomes real estate investors earn from selling assets they’ve owned for less than 365 days. These gains are typically taxed at standard income tax rates.

Long-term capital gains are the incomes real estate investors generate from selling assets after owning them for long periods. If you’ve owned a property for more than 365 days, you’ll have to pay long-term capital gains tax. This tax rate is typically lower than standard income tax rates.

These are the main tax implications of investing in real estate. Prepare for these taxes before you enter the world of real estate investing!

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