“Real estate is an easy way to make money.” It’s a sentiment I often hear from people looking to make their first foray into real estate investing. Recent research from Gallup shows that 34% of Americans think real estate is the “best long-term investment”—over “stocks, gold, savings accounts/CDs or bonds”—I’m not surprised that people believe real estate is an easy route to earning more.
But this belief is far from the truth. While real estate investing can be a great way to generate income, it is a challenging and competitive business that can be risky if it isn’t approached strategically. Consider this: According to 2023 data from Redfin, approximately “one of every seven (13.5%) U.S. homes sold by an investor in March sold for less than the investor bought it for.” Specifically, first-time real estate investors should do their due diligence to maximize their chances of leveraging key tax advantages that can come with real estate investing.
1. Avoid Buying Real Estate Solely For Financial And Tax Benefits
Anyone considering investing in real estate must understand the responsibilities associated with it. Namely, real estate is not a “set-it-and-forget-it” business.
Owning property is only one part of the equation. Getting financial and tax benefits requires effectively operating and managing that property and being a good steward of the business. Prospective first-time real estate investors should carefully consider whether they are properly trained and qualified—and willing to put in the time, financial resources and energy to effectively operate and manage any properties they purchase.
2. Work With A CPA To Calculate Depreciation
It’s common knowledge that real estate depreciation helps shelter income when tax season comes around. However, it’s essential for first-time real estate investors to work closely with CPAs to understand what level of depreciation to expect on a given property. A CPA might recommend a cost segregation analysis, enabling them to pinpoint opportunities to accelerate the typical 25-year depreciation schedule. For instance, real estate investors can get more depreciation value upfront by depreciating some items over a five-year schedule.
3. Use 1031 Exchange Laws To Defer Taxes
Moreover, by strategically navigating depreciation, first-time real estate investors can put themselves in a better position down the line if they want to pursue a 1031 exchange, which Investopedia describes as “a swap of one investment property for another” that enables shifting “the form” of an investment without “cashing out or recognizing a capital gain.” Investopedia further explains that when a “depreciable property is exchanged,” it can “trigger a profit known as depreciation recapture, which is taxed as ordinary income.” Using the advice of accountants and real estate attorneys, real estate investors can sell their first property and buy another one without depreciation recapture, essentially deferring their capital gains—which yields the benefit of compounding interest.
4. Explore Opportunity Zones
In my opinion, all new real estate investors should explore purchasing property in opportunity zones, which were created in 2017.
According to the IRS, opportunity zones “are an economic development tool that allows people to invest in distressed areas in the United States.” Investing in opportunity zones comes with tax advantages, including the ability to “pay no taxes on any capital gains produced through” an Opportunity Zone investment, provided that it is “held for at least 10 years,” as explained by the Tax Policy Center. In other words, there is no depreciation recapture with opportunity zones.
However, opportunity zone investments can be complicated to navigate for even experienced investors. Based on my years of experience working with opportunity zone investments, first-time real estate investors should research the areas around the country that the federal government has deemed opportunity zones to identify properties that could make suitable investments. From there, they have to ensure they can meet all applicable requirements.
5. Have A Solid Business Plan In Place
Sometimes, new real estate investors get started without a solid business plan. They don’t have a sound strategy and instead more or less “play it by ear.”
But this is a mistake. Before purchasing property, all real estate investors need to have a solid business plan in place that outlines critical factors, including how they will add value to the property, how they will maintain and operate the property, how they will keep the property competitive and which substandard elements of the property they will immediately address. These elements are a few of many they need to iron out before putting down a deposit. A property purchase without a plan can quickly derail.
Then there’s the creative side of a business plan. Real estate investors, both newbies and those with more experience, should think outside the box about how they can alter a property to make it better than it currently is. For instance, maybe they can add an in-law suite to raise its value. On a broad level, I recommend that all real estate investors better their properties by following ESG best practices.
Additionally, real estate investors should consider how they plan to give back to their communities (or the communities their properties are located in). Specifically, how can they leverage the property to enhance and enrich the given area? Some ideas include designating a percentage of units at an apartment complex for low-income housing, setting aside conference rooms or office spaces in a commercial property for local nonprofits to use or donating a portion of rental income to local organizations and causes.
6. Hire And Retain The Right Advisors
Given how complicated federal and local civil, property and tax laws are, it can be challenging to get the correct answers—which makes it crucial for new real estate investors to hire and retain the right advisors along the way, and not just in the initial stages of their real estate ventures. Tax attorneys, CPAs and other experts can help first-time real estate investors stay on the right side of the law.
With rising life expectancies, there’s a greater need to invest and save. Living longer equals the need to make more money. By investing in real estate in a tax-efficient, legal manner, first-time real estate investors can set the stage for longevity in the industry—longevity that can finance the rest of their lives.