Being a real estate investor can give you tax advantages. When calculating the cash flow from prospective property investments, it's wise to factor in the amount of money that you can save on your annual income tax burden. In addition to standard rental property deductions, some investors may qualify for federal tax credits to increase their return on investment.
Credits vs. Deductions
Tax credits impact your annual income tax return differently than deductions. A credit amount is subtracted directly from the total annual tax that you owe. A deduction reduces your taxable income. Deductions can make your tax bill smaller, but credits are guaranteed to lower your income tax burden. There are federal credits for a number of activities, such as education and certain types of real estate investing. Deductions for investment property owners include expenses, such as mortgage interest, repairs and capital improvements.
The Internal Revenue Service (IRS) offers investors a credit to rehabilitate some residential or non-residential properties. The credit applies to a portion of the costs to renovate, restore or completely reconstruct. For buildings placed in use before 1936, you can receive a tax credit worth 10 percent of your expenses. If you purchase and rehabilitate a certified historic structure, you may be due a 20 percent tax credit based on your costs. If the buildings are in a disaster area, such as those impacted by certain hurricanes, your tax credits increase to 13 and 26 percent, respectively. As of the time of publication, in order to qualify for the tax credit, you must spend $5,000 in a 24-month period.
Low-Income Housing Credit
The U.S. Department of Housing and Urban Development (HUD) oversees the Low-Income Housing Tax Credit (LIHTC) Program. The goal is to encourage private sector residential developers to build affordable housing. Tax credits are given to builders, who then sell them to investors to raise money for low-income housing. The investors, in turn, can benefit from tax credits for 10 years for each dollar invested, as long as the building qualifies for the program. It must be residential real estate, meet low-income tenant eligibility and be rent controlled.
For rehabilitation tax credits, you must notify the Department of the Interior if your project is not certified as completed by the end of 30 months, and you already claimed the credit on your taxes. As of the time of publication, to be eligible for the LIHTC Program, 20 percent of the apartments in your rental property must have tenants whose incomes are 50 percent of the area median or less. Alternatively, you can choose to qualify by designating 40 percent of your units as rent controlled and reserved for tenants whose income is 60 percent of the area median or less.