Real estate investing has numerous tax benefits, including the option to deduct certain expenses.

In this article, we’ll explore the tax implications of investment property loans to help investors navigate tax season with ease.

What is an investment property loan?

Investment property loans are used to finance the purchase or improvement of a property with the primary purpose of generating income or profit.

These loans are designed for those looking to invest in real estate, such as rental properties or properties intended for resale.

There are various types of investment property loans, including:

• Conventional loans
• Government-backed loans, such as FHA or VA loans
• Home equity loans or home equity lines of credit
• Debt service coverage ratio (DSCR) loans

Every loan has its own unique set of requirements, such as minimum down payment, minimum credit score, length of term, owner occupancy, how the property is used and other similar conditions.

How are real estate investments taxed?

Real estate holdings are subject to various taxes based on the type of investment, the holding period and the jurisdiction in which the property is located.

Here’s a general overview of how real estate investments are commonly taxed:

• Property taxes: Calculated based on the assessed value of the property; used to fund local services
• Income taxes: Income tax generated from renting out properties
• Capital gains: Applicable when a property is sold for a profit

One of the greatest benefits of investing in real estate is the ability to deduct expenses, such as mortgage interest, depreciation and the costs of owning and managing the property.

What are the tax implications for investment property loans?

Real estate investors must consult with a tax professional to navigate the complexity of investment property loans.

Tax laws can vary, and personalized advice can help optimize tax outcomes based on individual circumstances and the specific details of the investment.

Let’s take a look at the tax benefits investors need to know so they can access maximum savings at tax time.

Mortgage interest deductions

Real estate investors can deduct mortgage interest payments on investment property loans from their taxable income.

This deduction can help lower the overall tax liability associated with the property.

Operating expenses

Investors can deduct operating expenses related to owning and maintaining the investment property, including:

• Property taxes
• Repairs
• Maintenance
• Supplies
• Utilities
• Advertising
• Insurance
• Home office

The IRS recommends detailed record-keeping to prepare your tax returns because if a taxpayer is audited they must be able to produce evidence to support the information listed.

Keep track of all receipts, travel expenses and any relevant rental property financial documentation to ensure you’re supplying accurate information on your tax forms.

Depreciation

Property owners can claim depreciation on the property as an expense, reducing taxable income. Depreciation is based on the cost of the property (excluding land) spread over its useful life.

According to the IRS, three factors determine how much depreciation a taxpayer can deduct each year:

• The total amount of investment in the property
• The recovery period for the property
• Depreciation method

Review IRS Publication 527 for more information.

Capital gains tax

Capital gains refer to the profits made from the sale of an asset, such as real estate.

There are two types of capital gains:

• Short-term capital gains: From the sale of a property held for one year or less
• Long-term capital gains: From the sale of a property held for more than one-year

Short-term capital gains are taxed at the individual’s ordinary income tax rates, which can be higher than rates for long-term capital gains.

Long-term capital gains are generally subject to lower tax rates than short-term capital gains. The specific rates may vary based on the taxpayer’s income level.

Real estate investors can potentially defer capital gains with a 1031 exchange, which allows real estate investors to sell one property and reinvest the proceeds in a similar “like-kind” property without immediate tax consequences.

No Social Security and Medicare taxes

Income generated from real estate investments, such as rental income, is generally not classified as earned income for tax purposes. As a result, investors can benefit from an exemption from FICA taxes.

FICA taxes consist of Social Security and Medicare taxes, and they are typically withheld from an individual’s paycheck for contributions to these programs.

How do real estate investors report income and expenses?

Real estate investors are instructed to report their income and expenses on Form 1040 or 1040-SR, Schedule E, according to the IRS.

Investors with more than three rental properties can fill out and attach as many Schedule Es as necessary.

If an investor has personal use of a vacation home or residence where they rent a unit, the expenses may be limited.

Fix-and-flip investors have different tax implications because the IRS classifies them differently than rental property owners.

Work closely with a trusted mortgage loan officer, accountant and attorney to make certain you are making the best decisions for your unique investment property loan scenario.

Apply for an investment property loan with Compass Mortgage

The tax implications of investment property loans can be complicated. For that reason, we encourage you to consult with a certified accountant or tax attorney prior to making any decisions. The purpose of this article is to provide basic information for interested investors.

Once you’ve determined a plan for investment, partner with Compass Mortgage to experience our simple, personalized loan process backed by the power of industry-leading technology.

Compass Mortgage is “Home to a Better Mortgage Experience” because we believe our corporate culture, work ethic and results set us apart.

We care about and value your financing needs, and we understand the unique challenges and opportunities that real estate investors face.

We also know that the best real estate deals are backed by a true partnership between borrower and loan officer, thus opening the door to many lucrative deals to come.

Apply now to start the loan commitment process.

Our Get Committed® program will put you in the best possible position to win the property you want, especially in an intense seller’s market.

We look forward to partnering with you to fund your next investment property!