One of the unique advantages of investing in real estate is that investors can harvest profits from rental properties without paying taxes.
So in this article, we explore two methods of taking the profits generated by rental properties tax free.
Rental Properties Build Equity
In general terms, profitable rental properties generate rents that pay the financing costs, building up equity every year and adding to the real estate investor’s wealth.
At some point, most real estate investors want to access the equity built up in their rental properties. But, the problem is taxes.
Below, we discuss two methods of taking profits generated by rental properties without paying taxes.
#1 Cash-Out Refinancing
Real estate investors can refinance their rental properties and take out cash, just like homeowners.
The concept is simple:
- An investor purchases a rental property and leases it to tenants.
- Tenants pay rent, and a portion of the rent pays the financing for the property.
- The property builds equity over time.
- The investor refinances the rental property and takes cash out, without paying taxes.
- The investor repeats this process, periodically taking profits in the form of cash without paying taxes.
If you are considering cash-out refinancing, check with your lender about details to qualify for this type of mortgage. In most cases, you must own the property at least a year, and the maximum loan-to-value (LTV) will be 70%-75%, depending on the circumstances. So, if you have a minimum of 40% equity, cash-out refinancing may make sense.
If you have owned the investment property 6 months or less, you can use delayed financing to get cash out of the property.
#2 1031 Exchange
A 1031 Exchange does not allow you to pocket cash, like cash-out refinancing, but it is a very powerful tool to harvest profits from investment properties tax free.
Normally, when you sell an investment property for a profit, you owe taxes on the capital gains. However, the 1031 Exchange Rule allows you to defer the taxes by exchanging the property.
Advantages of deferring taxes with a 1031 Exchange are:
- Investors can grow and diversify their real estate portfolio more quickly, by essentially “swapping up” their properties indefinitely.
- Investors can exchange one property for up to three properties, and realize an increase in total value to a maximum of 200% of the exchanged property.
Graystone Investment Group
Graystone Investment Group is an experienced real estate wholesaler in Tampa Bay. We serve clients who flip homes in as little as 30 days, as well as clients who hold high cash flowing rental properties.
Unlike other wholesaling groups, we provide clients with a turnkey process at no extra charge. We find properties that we resell to investors at discount prices, while also connecting them with private financing. We also coordinate with rehab and management companies we’ve worked with for years.