There are many reasons why physicians invest in real estate, including for additional income streams and income diversification, passive income, and the potential for outsized appreciation or ‘infinite returns.’ One of the largest ones, though, is to get some tax advantaged income, as especially employed physicians don’t have a lot of opportunities for these. Depending on how involved in real estate you are, these tax benefits can be quite large, including the ability to reduce your taxable income on your physician income through outlets like claiming real estate professional status or the short term rental tax loophole. Below, we’ll go over some of the various ways doctors can get tax benefits from real estate investing depending on the type of investment and level of involvement.
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Why do physicians look to real estate for tax benefits?
If you’re a physician, you likely pay a lot in taxes. That’s just a fact of life for most physicians. Of course, we are fortunate to be in a position where physicians make great income, and are of course accordingly asked to contribute to taxes.
That said, many physicians find that a lot of the tax deductions or advantages open to others are closed off to them as employed physicians (which ~70% of physicians are). The tax code heavily favors business and real estate owners, whereas high earning W2 earners can’t benefit from a lot of the nuances of the tax code that open up tax deductions or credits. If you’re a physician earning W2 income, there are limited opportunities for tax strategy.
That is, unless you opt to have a side gig, be a private practice business owner, or invest in real estate. We have another article about tax deductions for physicians with businesses or 1099 income. We'll focus on the tax advantages of real estate here.
All of these deductions and tax advantages should be discussed with your tax professional before assuming they apply to you. Remember that we are not accountants and these potential benefits may or may not apply or make sense to your personal situation.
What are the tax advantages or deductions with investing in real estate?
Depending on what type of real estate investing you do, you will open yourself up to different tax deductions. We’ll go over some of the most common, as well as discuss some specialized ones that can really amplify the benefits.
QBI deduction for those investing in REITs
The Qualified Business Income (QBI) portion of the current tax code in 2024 allows you to deduct 20 percent of qualified real estate investment trust (REIT) dividends. This may change in future years, but at the moment is a nice caveat to the QBI rules, which many physicians otherwise wouldn’t qualify for.
Learn more about the QBI deduction.
Deductions related to depreciation from paper losses (even if you’re making money!) that allow you to pay less or no taxes on the cash flow coming in from your real estate investments
This is a complicated concept with nuances that should be discussed with an accountant with experience in real estate, but basically while your investment itself may be increasing in value, the IRS allows you to depreciate the hard assets of your building over time according to a set schedule on your tax return. This can be written off against the profits of the cash flow from your rental properties, which is part of the reason you hear some real estate investors saying that they don’t pay taxes on their real estate income (or, as you’ll read below, that they can actually use the depreciation to offset the taxes they pay on their clinical income in specific circumstances).
You may even hear some people talking about the concept of bonus depreciation, which allows you to accelerate that schedule and take the vast majority of the depreciation in a given year.
This is a tool used in both passive and active real estate investing.
1031 exchange allows you to defer taxes indefinitely, possibly permanently
Many real estate investments will allow you to roll your profits into the next property, allowing you to defer taxes on the capital gains indefinitely. The 1031 exchange is a component of the tax code that allows those investing in real estate to effectively swap out the money or value of one property they hold for another without triggering a tax event that will force them to pay capital gains taxes at that time. Of course, there are specific criteria established by the IRS for that must be followed. This includes that the money from the sale of a property must never come to you directly but rather be held in escrow by a third party and then used to buy the new property, and that that the new property must be considered “like-kind” or similar enough by the IRS to defer capital gains taxes.
There is no limit to how frequently or how many times you can do this, so you can continue to trade properties indefinitely and defer capital gains taxes. You can also actually pass down the property to your heirs, and at the time of your death, the property will incur a step up in basis, meaning that the tax basis of the investment will reset to its current value, and your heirs will not have to pay taxes on the profits that were incurred during your lifetime.
This predominantly applies to active real estate investing, such as owning long term rentals, short term rentals, mid term rentals, or medical office buildings. You can also use them in passive real estate investing but only if an investment is set up in the right way from the get-go to accommodate this, so check with your syndicator before assuming you can use this.
Write off expenses and get tax credits related to your real estate business
When you rent an active real estate asset, you are effectively running a business, and with that comes the ability to write off expenses and take deductions related to your business. For example, if you have a short term rental and travel to visit the property, you may be able to write that off. You may also need technology or a car or hire your kids to help with the real estate business. If you invest in a conference or course that teaches you about real estate investing, that may also be a deductible expense (but as always, check with your accountant, as there are nuances).
Take deductions from shared expenses or rental activity related expenses in house hacking
If you want to rent a portion of your house or property to someone else, this can lead to tax benefits, while also accelerating your pathway towards financial independence and financial freedom. Not only can the cashflow from rent be directed towards the mortgage to pay down the mortgage faster, but you can take tax deductions from shared expenses or related to rental activity.
We explore this more on our article about house hacking.
Use depreciation from active real estate investing to offset the taxes you pay on clinical income via Real Estate Professional Status (REPS) or the Short Term Tax Loophole (STR Loophole)
Real estate professional status (REPS) and the short term rental tax loophole are likely the biggest and most glorified tax benefits of real estate investing. While not every physician can qualify depending on their personal situation and how many properties they own, if you qualify to claim these on your tax return, you can not only make your real estate income tax advantaged, but actually use the deductions from the real estate investments offset your clinical income. These warrant a more in-depth discussion, which we go into below.
The biggest tax benefits in active real estate investing
When you hear people saying they pay no income taxes because of their real estate investments, they are likely claiming one of these two things on their tax returns.
Real Estate Professional Status (REPS)
This does NOT require that you have a real estate license or are a real estate agent. This is a status that those that invest actively in real estate can qualify for if they meet the appropriate criteria, and which allows them to actually use the paper losses from their real estate investments to offset their taxable income from their clinical income. One big criteria here, though, is that you must spend more time on real estate investing than anything else, which means that if you work full time as a physician, you yourself will not qualify. However, if your spouse does this more than anything else (so great for stay at home spouses or spouses that work part time), you will qualify to claim this status if you file married filing jointly. Some physicians even elect to cut down to part time to get this tax benefit. Another big criteria is the number of hours you must spend on real estate related activities, so typically (but not always), you will need more than one property to qualify.
We have a dedicated article on real estate professional status (REPS) that dives into the details.
The short term rental tax loophole (STR loophole)
Similar to REPS, the short term rental tax loophole allows you to claim the paper losses from your real estate against your clinical income. However, unlike REPS, you can work full time as a physician without having your spouse have to be eligible to claim the STR loophole on your taxes, which has led to a rise in the number of physicians investing in short term rentals or having these as part of their investment portfolio. Short term rentals must have an average stay of 7 days or less to qualify as short term rentals, and there are as expected, other criteria that must be met to qualify in terms of hours and material participation.
We have a dedicated article on the short term rental tax loophole that dives into the details.
Conclusion
Real estate investing is attractive to physicians for many reasons, of which one of the biggest is the opportunity for tax advantaged income. While the types of tax advantages you are eligible for will depend both on what you’re investing in and your personal circumstances, the breadth of opportunities to get involved in real estate investing offers physicians many ways in which they can get tax benefits based on their interest, time, and amount of money they have to invest.
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