Tax Rate

There are more than two dozen different sources of income, according to the IRS. Revenue, on the other hand, is divided into three

groups for practical purposes:

• Money generated via working for someone else or having your own business is earned income.
• Portfolio income includes bond interest payments, stock dividends, and capital gains realized when securities in a portfolio are sold.
• Passive income is revenue derived from royalties, limited partnership shares, and rental real estate.

Earned income vs. passive income

There can be a large difference between taxes paid on passive income and taxes paid on earned income, such as a full-time salary. Earned income is taxed at the employee’s total marginal tax rate, plus FICA taxes of Social Security and Medicare, totaling 15.3 percent, up to a specified amount. Passive income from real estate, on the other hand, is not subject to FICA and can be exempt from higher effective tax rates.

The following are examples of common rental property deductions that a real estate investor might use to minimize taxable net income:

• Fees for property management
• Repairs and maintenance
• Utilities
• Landscaping
• Legal and professional fees
• Wages are paid to a W-2 employee on a salary or hourly basis.
• Advertising expenses
• Fees for tenant screening
• Fees for commission, leasing, and referral
• Interest payments on a mortgage
• Property taxation

Real estate passive income is taxed differently than earned income. When you work for someone else or are self-employed and get a salary, your income is taxed at the full marginal tax rate and is subject to FICA taxes.

How is real estate passive income get taxed?

 In real estate, passive income is taxed in two ways, depending on whether it is recurring income or capital gain on sale when the property is eventually sold:

Recurring Revenue

The income generated by the property after rent is collected, operational expenditures and mortgage interest are paid, and depreciation is deducted taxed as passive income.

• Premiums for insurance

The amount of tax paid each year is determined by the tax bracket of the investment. According to the Tax Foundation, in 2021, federal income tax rates will vary from 10% to 37%. Although tax is still paid on real estate-generated passive income, depreciation can save a lot.

On the other hand, re

al estate owners have a 27.5-year window to depreciate the value of the building (excluding the land value). So, if the lot the house is built on is worth $15,000, the annual depreciation expense is $4,909 ($135,000 / 27.5 years).

An investor has $2,091 in taxable income after subtracting the depreciation expense of $4,909 from the $7,000 of income before depreciation. If the investment is in the 32% tax rate, the tax paid is $699. However, when the tax paid of $699 is compared to $7,000, the effective tax rate is around 10%.

Real estate investors must additionally pay capital gains tax when the property is sold. The amount of profit earned on the sale (if any) after recapturing and paying tax on depreciation incurred over the property holding term is referred to as capital gain.

ALso Read: Passive Income For College Students