The IRS has a label to classify everyone and one you don’t want next to your name as a property investor is: ”dealer.” The biggest reason for this is that it can result in you owing double FICA taxes – a total of 15.3% in addition to your federal, state, and local income taxes.
If you’re considered a dealer rather than an investor in the eyes of the IRS, you’re considered self-employed and would be responsible for paying both the employer and employee portion of the FICA tax.
Understanding FICA Taxes
FICA stands for the Federal Insurance Contributions Act. It’s used to fund Social Security and Medicare. These taxes are typically withheld from an employee’s paycheck and matched by their employer. However, investors often have a more complex tax situation, which can lead to the risk of double FICA taxation.
Strategies to Manage Risk
The best way to mitigate your risk of paying double FICA taxes and ensure compliance with all complex tax regulations is to work with a tax professional. Additionally, these strategies can help.
- Hang on to properties for more than a year – Not only does this mitigate your risk of being classified as a dealer, but it also allows your profits to be taxed at a capital gains rate rather than taxed as normal income.
- Consider using an entity structure – Using an entity structure like an LLC, partnership or S-corporation can provide tax advantages and potentially reduce your self-employment tax liability.
- Maintain accurate records – Always a best practice, keeping thorough records of your income and expenses related to your property investments is essential come tax time and if you need to defend your tax position during an audit.
Tax incentives offer clear benefits to real estate investors, but navigating them all can be complex. To ensure you’re maximizing your opportunities and mitigating risks, consult a professional, and to learn more about investing in the local market here in Columbus, come talk to us at RL Property Management.