5 tax strategies that pay off in real estate and homeownership

Since homes often represent clients' biggest asset and area of expense, financial advisors and tax professionals can help homeowners unlock savings and income in their own backyards.

The five tax strategies collected in the roundup below come courtesy of interviews with Sam Petrucci, the head of advice, planning and fiduciary services for New York-based Neuberger Berman Private Wealth, and Greg Clement, CEO of real estate investment technology firm Realeflow.

The strategies they suggest each carry their own potential caveats and downsides for some clients. They also show why the ideas extend far beyond the lower federal mortgage interest deduction that's currently in effect under the Tax Cuts and Jobs Act, the highly specific "Masters" or "Augusta" rule or the many available credits for energy efficient home improvements.   

Taxes play "a key part" in any kind of real estate investing, Clement said.

"A lot of people get into real estate to make more income, but what we realize is it's not how much you gain, it's how much you keep," he said.

On the surface, the lower levels of itemization for deductions in areas like mortgage interest, state and local taxes or moving expenses with the present guidelines may suggest there are much fewer opportunities. However, tactics such as a qualified personal residence trust, changing a client's residence to a state with lower taxes or renting out space in a home can still install a foundation of substantial savings for the owners. 

Just as many certified financial planners and large wealth management businesses found it beneficial to move locations during and after the pandemic, high net worth and ultrahigh net worth clients have turned residency into "a clear topic of interest," Petrucci said. 

The favorable tax treatment for residents' income in Florida and Texas acts as a magnet for those fleeing states such as New York, California, New Jersey, Massachusetts and Illinois. State-level estate taxes are playing a role in moves as well, Petrucci noted.

"Financial advisors should be educated on all of these issues so that they can speak intellectually with their clients about major complications as they contemplate moving to a new state," he said.

READ MORE: Advisors' rush to no-tax Florida spotlights hunt for wealthy clients and work-life balance  

Establishing a new residence

When leaving a high-tax jurisdiction like New York, buying a home in a new state and relocating there is just the starting point for getting the lower rates. 

Clients need to establish residency to avoid extra tax burdens in their former state. To do so they should adjust their estate plans, voter registrations and car records; enroll their children in a local school; find new, local doctors; join clubs in their adopted area; and ship their most valuable jewelry or other household items to their new home, according to Petrucci. In addition, they'll need to be "really mindful" of the amount of time they spend in their old state while "keeping accurate records" to back up those figures, he said.

"New York can continue to tax you if it's deemed that you are domiciled in the state of New York, and that is a bit of a subjective determination based on a variety of factors," Petrucci said. "If you're a New Yorker and you want to establish a residency in Florida you must abandon New York for all intents and purposes. … You want to check the box on each of these items so, in the case of an audit, you have a strong case."

Property tax deduction

On the other hand, some states that have lower income taxes may collect higher property taxes. The cap of up to $10,000 in federal deductions for state or local taxes under the Tax Cuts and Jobs Act reduced the potential exemptions for clients, but it didn't wipe them away entirely, Clement noted.

Based on "all of my conversations with CPAs and tax attorneys over the past 15 years," the possible exemption for property taxes "is one of the most overlooked deductions," he said. "That's a big deduction for people."

READ MORE: 20 states that burden individuals the least

Qualified personal residence trust

For those looking past yearly bills into the long-term future of an estate, a qualified personal residence trust could remove the higher gift-tax hit from a property's appreciating value before they leave it for a child or another beneficiary, Petrucci noted. The strategy works much better for a vacation home rather than a permanent residence, where a parent could end up paying rent to their son or daughter at the end of the trust's term.

"It's an elegant way to transfer real estate down to the next generation in an efficient manner for tax and gift purposes," Petrucci said. 

House hacking

"House hacking" refers to chopping up a residence in order to rent out a portion of the home to a tenant — usually when the owner is living there as well. The gambit poses some challenges in the form of finding a tenant and welcoming a new resident to the premises. It pays off particularly well, though, when the property is already a multifamily duplex or triplex and the owner can use the deductions for mortgage interest and property taxes or "go deeper" into depreciation methods with an advisor or another professional, Clement said.

"It's a popular concept that's growing quickly, especially in the Airbnb economy. People have been using this term in the real estate investing space for the last five or six years," he said. "Your tenants are paying your portion of the mortgage and, as a real estate investment property, you're able to get all of those deductions that are attractive to real estate investors."

READ MORE: 24 tax tips for self-employed clients

Home office deduction

Exemptions for the cost of expenses such as homeowner association fees or mortgage bills can give some small business owners whose office is part of their home relief that's tied to the amount of space they use on behalf of their company, Clement noted.

"For many people in this hybrid work environment, their home office would work," he said.