Did you have a great year in real estate? First off, congratulations! Finally seeing all of your hard work pay off is exciting. However, before you go purchase your “treat yourself” gift, you need to think about tax time.
Following the generic rule to save 30% of your income isn’t beneficial for all real estate professionals. In fact, this can either lead to over-saving or under-saving, depending on the specifics of your tax return.
As a result, tax planning is a crucial component of having a smooth filing season. Two of the components of your tax plan will be deductions and credits, both of which can help lower your tax bill. In this article, we’ll break down the differences between these two tax-saving items.
The Difference Between Tax Credits and Tax Deductions
Before we get into the differences between tax credits and deductions, we need to outline two terms: taxable income and tax liability. Taxable income is the amount of money the IRS taxes, while your tax liability is the gross amount of tax you owe. Now, let’s get into the details.
A tax credit is a dollar-for-dollar reduction of your tax liability. Let’s say you have $20,000 of taxable income and owe a $5,000 tax liability (25% of your income). If you are able to claim a $2,000 tax credit, the amount you owe will now be $3,000.
On the contrary, a tax deduction reduces your taxable income base. Using the above factors, let’s say that you are able to claim a $2,000 tax deduction. This reduces your taxable income to $18,000. If your average tax rate was still 25%, you would have a $4,500 tax liability.
From this example, we can see that tax credits are more powerful because they directly lower the amount due. However, many real estate agents can claim both deductions and credits to maximize tax savings. The below graphic is a summary of the flow of tax credits and deductions.
Common Real Estate Tax Deductions
Real estate agents are able to take a variety of tax deductions outside of the standard deduction. Let’s explore some of these credits in more detail.
Standard Deduction
The standard deduction is an automatic reduction of your taxable income based on your filing status. Each year, the IRS increases the amount for inflation. Here’s a table of the 2024 deductions.
Itemized Deduction
The alternative to claiming the standard deduction is using itemized deductions. Itemized deductions are comprised of the following items:
- Medical expenses above 7.5% AGI
- State and local taxes up to $10,000
- Mortgage interest
- Charitable contributions
If the sum of these expenses exceeds the standard deduction for your filing status, you can claim the higher threshold.
Qualified Business Income Deduction
The Qualified Business Income Deduction is an automatic 20% reduction of your net business income (revenue – expenses). This deduction is available for Schedule C filers, Partnerships, and S Corporations. The QBID is only available if your business has income. Any losses will offset future year deductions.
Home Office Deduction
The Home Office Deduction allows you to claim a portion of rent payments, mortgage expenses, utilities, property taxes, insurance, and repairs if you work out of a space in your home. For example, using a spare bedroom to complete your work. Real estate agents can either claim a standard deduction of $5 per square foot up to 300 square feet or use the actual percentage of the space in relation to the entire home. For example, if your office space was 400 square feet out of 2,000 square feet, you would be able to claim a 20% deduction on applicable items.
Section 179 and Bonus Depreciation Deduction
Section 179 and Bonus Depreciation allow you to claim extra depreciation on fixed assets in the year they are placed in service. Bonus Depreciation has started to phase out and is set at 60% of the asset’s cost basis for the 2024 tax year. Nevertheless, you can use Section 179 to immediately deduct new office furniture, equipment, and other items. Section 179 cannot create a loss and can only be used until your taxable income is $0.
Employer Tax Deduction
Real estate agents that file Schedule C will have self-employment taxes imposed on net income. The IRS allows you to deduct the employer portion of Social Security and Medicare to reduce your taxable income.
Retirement and Insurance Deduction
For qualifying self-employed individuals, you can deduct the cost of health insurance and some retirement savings contributions.
Common Real Estate Tax Credits
There are a number of credits available, including the Earned Income Tax Credit, the Child Tax Credit, the Child and Dependent Care Credit, the Credit for Other Dependents, and the Premium Tax Credit. Depending on the specifics of your return, you may be able to claim these items. Here are two more credits that you should consider claiming:
Vehicle Tax Credits
Real estate agents are constantly on the go. If you purchase a qualifying electric vehicle, you could claim a tax credit of up to $7,500 for new vehicles and $4,000 for eligible used vehicles.
Education Credits
If you decide to go to school to pursue a degree or take education courses, you might be eligible for a tax credit. The first tax credit is the American Opportunity Tax Credit, which provides a credit of up to $2,500 each year for four years. Up to $1,000 of this credit is refundable, meaning you can receive a refund if your tax liability is $0.
If you already used the American Opportunity Tax Credit for four years, you can claim the Lifetime Learning Credit. This is a credit of up to $2,000 per year, with no cap on the number of years you can use it.
Maximizing Your Tax Savings
Which of these credits and deductions do you qualify for? Maximizing your tax savings relies on claiming all eligible tax breaks. For personalized guidance on how to streamline your bookkeeping and ensure you’re capturing every tax-saving opportunity, feel free to reach out!