Purchasing Real Estate to save taxes this year? Be Smart about it!

Congratulations! You've had a great year in your professional life in terms of income and you've got a lot of excess cash and you're wanting to purchase an investment property to build your wealth. I think it's a great idea, but a lot of people have misconceptions or misunderstandings about how real estate tax benefits work and it can be a costly one (at least in the short term) and here's why. Below is a list of things to consider if you are in this situation to help make the best decision for you and your family:

1. The timing of when you purchase the property and get it rented is important - there is no current year tax benefit to purchasing an investment property that doesn't get rented by the end of the year.

2. Some renovations aren't able to be written off in the current year - instead the expenses you incurred to renovate the property are considered improvements and depreciated (in other words, the cost is spread out over many years) which results in a tax benefit that's reduced to very little in the current year and that benefit will be slowly released over a long period of time.

3. Paying back the mortgage principal is not a deduction, but the interest and real estate taxes are deductible - many don't understand that simply giving someone their money back doesn't provide a tax benefit, but that's want a loan is. You borrowed and it wasn't income, thus it's not a deduction when you pay it back except for the cost of the interest which is the lenders charge for loaning you the money.

4. The cashflow on the rental which is what people love the most is generally not going to be taxed and if it is, it won't be much.

5. Most of the tax benefits of having rental real estate are long term in nature and they are so good that it makes owning real estate very attractive - but you must appreciate the value of long term investment. In short, the appreciation on rental property can completely escape taxation altogether if done properly.

6. For current year deductions, one should consider short term (airbnb style) renting. This is a different style of renting and those who do this type of investing should make sure they understand how to properly run this type of operating and get assistance from those with expertise and experience in this area.

Due to these misconceptions, I've seen people purchase properties expecting a current year tax benefit and when that doesn't happen, they realize they don't have the money to pay the taxes on their professional income (see first paragraph), because they assumed the real estate investing would have saved them money on the taxes. In essence, they spent their tax money on the real estate investment. There's nothing wrong with investing, it's just better when you navigate this space with assistance from professionals that can advise you of the implications of your decisions and because they have consulted with you and have insight into your financial situation, that allows them to advise you better.