When you enter a higher tax bracket, you ought to consider a deeper involvement in your tax strategy. Earning a higher income doesn’t need to incur lower returns on your future investments when you pay your taxes at the end of the year. Calibrating an investment strategy that works in conjunction with your tax strategy can make a significant difference in the amount of money you take home on your returns.
Explore the opportunities you have to utilize income streams that provide you with great tax benefits at the same time with Christina.
What Can High-Income Earners Expect To Pay in Taxes?
Understanding what you’re expected to pay in taxes at the end of the year is a critical part of your financial health. Depending on where you live, there may be a drastic difference in what you’ll be required to pay.
However, no matter your state, you’ll always be expected to pay your federal taxes. Income tax is the most well-known tax; it’s the tax we pay at the year’s end on the total income we’ve earned over the course of the tax year.
Tax is levied based on income brackets. Increasingly higher brackets net larger percentages of tax on the corresponding income. For example, The first $10,000 dollars may be taxed at 10 percent, while proceeding income will be taxed at their designated rate.
Recent changes to the federal tax code were implemented by the Tax Cuts and Jobs Act of 2017, legislation that generally lowered the amount of taxes the average American pays on their income.
Income Tax Brackets for 2022
The federal income tax brackets for 2022 are as follows:
Single:
- 10 percent: $0 to $10,275
- 12 percent: $10,276 to $41,775
- 22 percent: $41,776 to $89,075
- 24 percent: $89,076 to $170,050
- 32 percent: $170,051 to $215,950
- 35 percent: $215,951 to $539,900
- 37 percent: $539,901 or more
Head of Household:
- 10 percent: $0 to $14,650
- 12 percent: $14,651 to $55, 900
- 22 percent: $55,901 to $89,050
- 24 percent: $89,051 to $170,050
- 32 percent: $170,051 to $215,950
- 35 percent: $215,951 to $539,900
- 37 percent: $539,901 or more
Married, filing jointly
- 10 percent: $0 to $20,550
- 12 percent: $20,551 to $83,550
- 22 percent: $83,551 to $178,150
- 24 percent: $178,151 to $340,100
- 32 percent: $340,101 to $431,900
- 35 percent: $431,901 to $647,850
- 37 percent: $647,851 or more
Married, filing separately
- 10 percent: $0 to $10,275
- 12 percent: $10,276 to $41,775
- 22 percent: $41,776 to $89,075
- 24 percent: $89,076 to $170,050
- 32 percent: $170,051 to $215,950
- 35 percent: $215,951 to $323,925
- 37 percent: $323,926 or more
Income from work or realized gains from liquidated assets contribute to your position amongst the income bracket. Unrealized gains from assets held in the long term do not factor into your income tax.
Why Is Real Estate Investing Such an Effective Tax Strategy?
Real estate stands apart as an asset class with distinct advantages that make it ideal for tax-based strategies. Compared to other capital assets, like securities, stock trading, or bonds, real estate possesses key advantages that are conducive to an effective tax strategy.
Real estate presents many perks as a capital investment, but more than any other advantage, the many tax break opportunities available to real estate investments are a must-have for a tax-based investment strategy.
There are few assets that appreciate with the same consistency as real estate, in addition to many more compelling benefits that dovetail with a tax strategy for high-income earners.
Here’s why real estate investing is the best way to implement a tax strategy that earns you more money:
What Tax Advantages Does Real Estate Have?
- Depreciation
- Write-Offs
- Long-Term Gains Tax Rates
Depreciation
The degeneration of real property over time is a fact of life; weather corrodes the roofing on a residential home; strains on a septic system lead to costly repairs. Normal wear and tear is a reality that inevitably besets all real estate assets.
Depreciation provides investors with significant means to make deductions on their real estate-generated taxable income. This deduction process accounts for these costly repairs that are to be expected in real estate acquisition and maintenance. Then, investors have the opportunity to make substantial write-offs to encourage the proper upkeep of their properties.
Property owners have had the opportunity to make these deductions on their taxable income for decades. The IRS outlines clear guidelines as to how investors can utilize depreciation on their property and gain the benefits of these tax deductions.
How Does Depreciation Work?
First, investors must establish the basis of the property. The basis of a property is the total value of the actual structures owned by the property owner.
When acquiring a lot, investors pay for both the land itself and the structures on it. Since land does not degenerate in the same way as the properties themselves, the value of the land must be excluded from the value that qualifies for the tax deductions from depreciation.
Secondly, property owners must establish a property’s “useful life,” the reasonable lifespan one can expect from a given property. The IRS outlines the standard of a property’s useful life based on the property type: residential properties have a designated useful life of 27.5 years; commercial properties have a useful life of 39 years.
Finally, investors divide the value determined by a property’s basis by the number of years in its useful life: this is the baseline deduction investors can make on the taxable income generated by their property each year. Depending on property specifics, adjustments may be available to net even larger deductions.
How Does Depreciation Affect a Better Tax Strategy?
Depreciation allows investors to generate tax-free income, potentially for decades. Rental properties that qualify for deduction can generate a substantial monthly cash flow, most of which will be tax deductible at the year’s end. Strong returns and tax-deductible income tend to be mutually exclusive; that’s not the case with depreciation.
Tax Write-Offs
Property ownership has a number of opportunities for tax write-offs, which makes real estate investing an excellent opportunity for a more complete return.
Real estate is a cornerstone of the economy. To sustain a steady influx of capital into the real estate market, the government offers a range of tax write-offs on property ownership to encourage increased participation from investors.
Property can be expensive, thereby deterring participation from investors due to seemingly insurmountable financial thresholds. However, for those that have the means to access real estate investment opportunities, the relatively high upfront costs pay dividends when the write-offs on property ownership come into play.
What Write-Offs Are Available on Real Estate?
Acquiring a property is just one part of managing real estate. Operating expenses add up and put additional costs on holding real estate assets. However, the vast majority of these operating expenses can be written off, turning these additional expenses into a stronger, tax-reduced return.
Here are a few tax write-offs investors can use on real estate assets:
- Property taxes
- Mortgage interest
- Insurance payments
- Repairs and maintenance costs
Property Taxes
The amount of property tax investors pay on their assets depends on both the state and locality in which the property is located; state property taxes vary, and local communities may have additional property taxes levied against property owners at the end of the year.
Property taxes are a deductible expense, offsetting these costs and creating a more complete ROI on income earned by the property.
Mortgage Interest
In all likelihood, real estate investors will take out a mortgage in order to acquire their assets. Mortgage interest rates are tax-deductible expenses. Paying off a home is a win-win for investors: the more equity investors build on their home by paying off their mortgage, the more they can write off at the end of the year.
Insurance Payments
Property insurance protects investors from catastrophic damage to their assets. Property owners may have a number of insurance plans for their property, like liability insurance for their tenants or plans that cover damage caused by inclement weather. Investors are incentivized to protect their property because insurance payments can be written off on their taxes.
Repairs and Maintenance Costs
Things are expected to fall apart over the course of the holding period of real estate assets. While a yearly deduction can be guaranteed in anticipation of these wear-and-tear expenses, investors still retain the opportunity to write off actual damages to their home. For example, repairs on burst pipes, replacing windows, and more can be written off.
How Do Tax Write Offs Affect A Better Tax Strategy?
The number of opportunities for write-offs makes real estate a compelling component of a tax strategy for high-income earners. With so many chances to write off expenses, investors can expect a better overall return. Real estate investments can offset their taxable income with these write-offs; the more you can write off, the more income you get to keep.
Long-Term Capital Gains Tax Rates
Between long-term capital gains rates and the high appreciability of real estate, investors are doubly incentivized to hold their assets for a stronger, tax reduced return.
Investors turn to real estate as a long-term holding due in large part to the historically high appreciability of property. Long-term holdings that can be reasonably expected to maintain a return are the cornerstone of a stable, secure portfolio.
Favorable long-term capital gains tax rates allow investors to take home more of their money when they qualify, making real estate an ideal opportunity to earn larger gains with fewer taxes on capital gains.
What Are Long-Term Capital Gains Tax Rates?
The federal government rewards longer holding periods as they may encourage a more stable market; more capital staying in the market sets a foundational baseline for its overall value.
Long-term capital gains rates generally come into effect when an asset is held for over a year. Short-term capital gains rates are far less favorable to investors, with rates that tend to be set at a similar level to earned income brackets.
Here are the current federal long-term capital gains tax rates:
Single taxpayers :
- 0 percent: $0 to $40,400
- 15 percent: $40,401 to $445,850
- 20 percent: $445,851 or more
Head of household:
- 0 percent: $0 to $54,100
- 15 percent: $54,101 to $473,750
- 20 percent: $473,751 or more
Married, filing jointly:
- 0 percent: $0 to $80,800
- 15 percent: $80,801 to $501,600
- 20 percent: $501,601 or more
Married, filing separately:
- 0 percent: $0 to $40,400
- 15 percent: $40,401 to $250,800
- 20 percent: $250,801 or more
How Do Long-Term Capital Gains Affect a Better Tax Strategy?
Historically, real estate held for the long term is virtually guaranteed to increase in value. If held, these unrealized gains build more wealth for investors without altering their income tax bracket level. When assets are finally liquidated, favorable long-term capital gains rates mean investors optimize their return, holding more and paying less in taxes.
Real Estate Investing Is the Cornerstone of an Effective Tax Strategy
Depreciation, write-offs, and long-term capital gains tax rates combine to make an essential asset for high-income earners and a favorable tax strategy. Investors have the opportunity to net better returns and pay fewer taxes because of the many tax reduced advantages available in real estate.
When creating a stronger tax strategy for high-income earners, the question isn’t whether they should invest in real estate — but how.
Invest With the Best
Christina is a real estate investment firm that’s thrived in one of the most competitive real estate markets on the planet: the Westside of Los Angeles. With the resources, the skill set, and the network to connect high-income earners with premium real estate, your portfolio will have the kind of real estate that gets you a better return and more tax deductions.
Get started with Christina today and build a better tax strategy for tomorrow.
Sources:
2022-2023 Tax Brackets and Federal Income Tax Rates | NerdWallet
Publication 946 (2021), How To Depreciate Property | IRS
Median Sales Price of Houses Sold for the United States | FRED
Topic No. 409 Capital Gains and Losses | IRS
Tax Cuts and Jobs Act of 2017 (TCJA) | Wex | US Law | Legal Information Institute