Smart Tax Tips for Landowners

Investing in raw land can be strategic for those looking to enter the real estate market without the significant upfront costs often associated with developed properties. Unlike residential or commercial real estate, raw land typically has fewer responsibilities, such as maintenance or tenant-related issues.

This makes it an attractive option for investors who prefer a hands-off approach. However, while raw land offers these conveniences, it is essential to be aware that its tax benefits are not as extensive as those available for improved properties. So, let’s dive into the smart tax tips for landowners.

Understanding the Tax Landscape for Raw Land Investment

When investing in raw land, you must navigate a tax landscape that differs from other real estate investments. While the tax benefits may be more limited, there are still opportunities to optimize your tax situation.

Deductible Expenses

One of the key areas where you can claim deductions is property taxes. Unlike residential properties, with a $10,000 limit on the deduction of state and local taxes (SALT), property taxes on raw land do not fall under this cap. This allows landowners to deduct yearly property taxes, potentially providing significant tax relief.

Additionally, if you’ve taken out a loan to purchase the land, the interest on this loan is deductible. However, it’s important to note that this deduction is limited to the amount of your annual investment income. Therefore, if your investment in raw land generates income, you can deduct the interest paid on your loan up to the amount of that income.

Non-Deductible Expenses

While some expenses are deductible, it’s equally important to be aware of what costs are non-deductible. Miscellaneous expenses, such as legal fees, insurance premiums, and travel expenses related to the land, currently do not qualify for deductions. These costs may return as deductible items in 2026, depending on legislative changes, but for now, they remain non-deductible.

Another significant non-deductible expense is preparing the land for future use. Whether you’re clearing the land, grading it, or making other improvements, these expenses cannot be deducted in the year they’re incurred. However, there is a strategy to mitigate the impact of these non-deductible expenses.

Understanding Property Tax Deductions

Property tax deductions are a significant benefit for landowners, allowing them to reduce their taxable income by claiming various expenses related to their property. Here’s a breakdown of common deductions available:

1. Mortgage Interest Deduction

Overview: Landowners who have taken out a mortgage on their property can deduct the interest paid on that loan from their taxable income.
Eligibility: To qualify, the property must secure the mortgage, and the loan must be used to purchase, build, or improve the property. Interest on home equity loans used for other purposes may not qualify.
Benefit: This deduction can significantly reduce your tax liability, especially in the early years of a mortgage when interest payments are higher.

2. Property Taxes

Overview: Landowners can deduct the amount they pay in property taxes on their real estate from their federal income taxes.
Eligibility: The deduction applies to state, local, and foreign property taxes assessed based on the value of the property. It’s important to note that this deduction is capped under the Tax Cuts and Jobs Act (TCJA) of 2017, limiting the combined deduction for state and local taxes (SALT), including property taxes, to $10,000 per year.
Benefit: This deduction helps to offset the cost of owning property by reducing the overall tax burden.

3. Improvements and Repairs

Overview: While not all home improvements are immediately deductible, certain improvements can be capitalized and depreciated over time, leading to tax savings.
Eligibility: Capital improvements that add value to the property, extend its useful life, or adapt it to new uses can be depreciated over several years. Examples include adding a new roof, installing a new HVAC system, or building an addition. On the other hand, ordinary repairs and maintenance are typically not deductible.
Benefit: By capitalizing on major improvements, landowners can gradually recoup some costs through depreciation, reducing taxable income over time.

Depreciation Benefits

Depreciation is a powerful tool for landowners to reduce their taxable income by spreading the cost of property over several years. Here’s a quick guide on how to leverage it:

1. Leveraging Depreciation

What It Is: Depreciation allows landowners to deduct their property’s gradual wear and tear over time, reducing their taxable income.
How It Works: The IRS allows you to depreciate a residential building over 27.5 years, while commercial properties are depreciated over 39 years.

2. Land vs. Building Depreciation

Land: Land itself cannot be depreciated because it doesn’t wear out or get used up. Only improvements like buildings and structures qualify.
Building: The value of the building can be depreciated, spreading the cost over its useful life. For example, if you purchase a property for $300,000, with $100,000 attributed to the land and $200,000 to the building, you can depreciate the $200,000 over the IRS-specified period.

3. Maximizing Depreciation Benefits

Cost Segregation: Divide your property into different components (e.g., HVAC, lighting) that may depreciate faster than the building itself.
Improvements: Capitalize on improvements that can be depreciated, like renovations, to increase your depreciation deductions.
Review Annually: Regularly review your property’s depreciation schedule with a tax professional to ensure you’re maximizing your deductions.

Conservation Easements and Charitable Deductions

1. What is a Conservation Easement?

Definition: A legal agreement that restricts land use to protect conservation values.
Purpose: Preserves land for wildlife, habitats, or public use.

2. Tax Benefits of Donating Land

Charitable Deduction: Deduct the land’s reduced value after donating a conservation easement.
Income Tax Reduction: Deduction can lower taxable income and carry forward for up to 15 years.
Estate Tax Benefits: Reduces estate value, lowering potential estate taxes.

3. Requirements and Benefits

Qualified Organization: Must donate to a qualified land trust or government entity.
Conservation Purpose: Must serve valid purposes like protecting habitats or open spaces.
Permanence: The easement is permanent, even with ownership changes.

Benefits

Tax Savings: Significant federal and estate tax reductions.
Legacy: Preserve the land’s value for future generations.
Flexibility: Continue traditional land uses within conservation guidelines.

Capital Gains Tax Strategies

1. Short-Term vs. Long-Term Capital Gains

Short-Term: Gains from selling land held for one year or less, taxed as ordinary income.
Long-Term: Gains from selling land held for over a year, taxed at lower rates.

2. Tips to Minimize Capital Gains Taxes

Hold for Long-Term: Keep the property for over a year to qualify for lower tax rates.
1031 Exchange: Defer taxes by reinvesting sale proceeds into similar property through a 1031 exchange.
Offset Gains with Losses: Use losses from other investments to offset capital gains.
Installment Sale: Spread the income from the sale over several years to reduce tax impact.
Primary Residence Exclusion: If the land includes your primary home, exclude up to $250,000 ($500,000 for couples) of gains.

Landowners can effectively manage and reduce their capital gains tax liabilities by understanding these strategies.

Maximizing Your Tax Benefits

If you cannot itemize deductions due to limitations or the nature of your expenses, there is an alternative approach. You can elect to capitalize your deductible costs instead. This means that instead of claiming the deductions in the year, you can add these expenses to the cost basis of your property.

By increasing your cost basis, you effectively reduce the amount of taxable profit when you sell the land. This strategy can result in a lower capital gains tax, which can be a significant benefit, especially for long-term investors. So, I believe these smart tax tips for landowners will help.

In summary, while investing in raw land offers a straightforward and affordable way to enter the real estate market, it’s crucial to understand the tax implications. By strategically managing your deductible and non-deductible expenses and considering options like capitalization, you can optimize your tax outcomes and enhance the profitability of your investment in raw land.