With Texas’ pro-business political environment creating jobs, its diverse economy, and booming cities, Texas has long been a desirable state for real estate investors. It’s the main reason my wife and I chose to begin our real estate portfolio 10 yrs ago in Texas. Today, we have over 40 rental units that are all positive cash flow and minimizing our annual taxes.
Texas is also tax-friendly for real estate investors, providing one more reason to put your property investment dollars in the Lone Star State. Here’s what you need to know about Texas tax laws as a real estate investor, as well as an overview of how the Texas tax system is beneficial for real estate investing.
Texas Income Tax Relating to Real Estate Investing
Alongside Nevada, South Dakota, Washington, Wyoming, Alaska, and Florida, Texas does not collect personal state income tax. That doesn’t mean you won’t pay income tax to the IRS for federal taxes, but it means you’ll pay less overall income tax in Texas. And even if you don’t live in Texas, you can benefit from the state’s lack of income tax as an investor, which I’ll explain later.
But first, it should be noted that Texas taxes corporations that conduct business, earn income, or operate within the state, and that this tax is calculated as 1% of annual revenues above $1M. However, as a real estate investor, you can avoid this tax, and take advantage of Texas’ lack of a personal income tax to pay a lower effective tax rate on your real estate investments if your investment corporation earns less than $1,030,000 in annual revenues. Sounds like a pretty good deal eh?
Now, before proceeding to talk about specifics regarding taxes relating to real estate investing in Texas, I should remind you that we are not accountants or tax lawyers, so consult your tax and legal professionals before doing anything relating to taxes and real estate investing. With this in mind, let’s continue.
Types of Taxable Entities in Texas
When conducting real estate transactions, collecting rent, or earning commercial property dividends from a Texas real estate investment, you will be taxed at the state’s 1% marginal tax rate for annual revenues greater than $1,030,000. You can get around this by filing as an “S” corporation, but there are still easier ways to escape business taxes in Texas.
#1 Sole Proprietorships and Partnerships
Sole proprietorships are defined as businesses owned by a single individual, and in Texas there is no distinct business or corporate tax on sole proprietors. And since there is no income tax leveraged on individuals in Texas, you can invest in real estate as a sole proprietor without paying state income tax.
The same goes for partnerships; Texas does not leverage a state-specific tax on partnerships. And while most states tax the revenue generated from partnerships, Texas does not. This means you can invest in Texas real estate as either a sole proprietor or partnership without paying state income tax!
Though perhaps a little more confusing, operating as an LLC in Texas can still afford real estate investors the benefit from Texas’ lack of an individual income tax. But, the LLC has to be setup properly to enjoy this tax benefit.
To form an LLC in Texas while living in another state, you’ll need an agent living in Texas to serve as a “resident agent”. If your LLC is composed of multiple members, it will usually be treated as a partnership for tax purposes, meaning you will not pay state income tax. Furthermore, if you are the only owner in your LLC, it will be treated as a “disregarded entity”, and you won’t pay state income tax.
Be aware, though, that it’s possible to setup an LLC so that it’s treated as a corporation under Texas tax code, which would result in paying Texas taxes. So, use a professional to setup your LLC to take advantage of no state income tax in Texas.
Watch Out for These Complications
Texas’ lack of a personal income tax makes it a great place for real estate investors to conduct business. However, there are a few ways this picture can be complicated by external factors.
First off, depending on what state you live in, your state may leverage an income tax on income generated out of state, even if that income comes from a non-taxable legal entity in Texas.
Similarly, if the legal entity that you’ve formed to operate in Texas conducts business in other states, you may fall victim to “nexus” based taxes. “Nexus” exists when a business operates in more than one state, and the rules and regulations for businesses that fall into this category are extremely complicated. Again, consult tax and legal professionals before doing anything relating to taxes and real estate investing.
Things To Consider Regarding Out-of-State Real Estate Investing
From a tax perspective, there are numerous benefits for real estate investors in Texas. But if you live outside of Texas, there are logistical concerns to keep in mind.
Anytime you invest in real estate outside your home area, you need to do a great deal of out-of-town research to learn where to purchase investment properties. Plus, from a financial perspective, managing properties and tenants from long distance can be impractical, besides dramatically cut into your profits.
The solution, then, is to use local real estate professionals to find, purchase, rehab, maintain, and manage your investment properties. Though this cuts into your profits compared to self-managed real estate investments, investors aggressive enough to invest out-of-state probably use these professionals for all their real estate holdings anyway. Approach your real estate investments as a business and manage it like a company, not a hobby. The key to any successful business is to build a team that can help you execute on your vision of generating wealth through real estate. These don’t have to be large teams to get started, but I would recommend a real estate attorney, real estate broker, property manager, and an accountant to get started.
The Bottom Line
There are major tax benefits for real estate investors in Texas compared to most other states. If you are interested in real estate investing in Texas, consult your tax and legal professionals to learn how you can take advantage of Texas tax laws. Hopefully, you can significantly increase your profits and wealth while reducing your income tax burden.
When you are ready to start your journey to building wealth through real estate, Real Estate Concierges can also help you setup the team to achieve your financial freedom, such as property management, accountant, legal advisors, and real estate services.
To start working with Mile27, please contact us at 855-732-6700 or contact us directly online.