You have probably heard the phrase "buy real estate to save on taxes." Certainly, there are aspects of real estate investment that can help reduce tax burdens. However, we would like to sound a warning against holding real estate solely for the short-term tax-saving effect.
In this article, we propose a new perspective that rethinks real estate not as a mere "tax-saving measure" but as a "family strategy" to protect the future of the family and pass on assets from generation to generation. We will explain in an easy-to-understand manner, with expert knowledge, specific methods to maximize asset value from a long-term perspective, without being preoccupied with immediate profits.
Why is real estate discussed in the context of "tax reduction"?
The main reason why real estate is associated with tax savings is due to its unique tax structure. Of particular importance are "depreciation" and "profit and loss" deductions.
Depreciation and Profit and Loss Recognition Mechanisms
Based on the idea that the value of the building portion of real estate decreases over time, the decrease in value of the building portion of real estate is allowed to be recorded as an annual expense as "depreciation. The main feature of depreciation is that it is an "accounting expense" that does not involve an actual cash outlay.
After deducting depreciation and other expenses from income earned from real estate management (e.g., rental income), a deficit may appear on the books. By offsetting this deficit with other positive income such as employment income (through profit and loss), the total amount of income subject to taxation can be reduced. As a result, the income tax and inhabitant tax burdens are reduced. This is the basic mechanism of "tax reduction through real estate.
| Item | Amount (yen) | Remarks |
|---|---|---|
| Rental income | 5,000,000 | Annual |
| Necessary expenses | 1,500,000 | Management fee, repair cost, property tax, etc. |
| Depreciation and amortization | 4,000,000 | No actual expenditure |
| Real estate income | Real estate income ▲ 500,000 | Deficit on the books |
In the above example, a deficit of 500,000 yen can be deducted from employment income, etc.
Trap posed by holding real estate as a short-term tax-saving scheme
However, there are many points to be aware of in this tax-saving scheme. Purchasing real estate for the purpose of easy tax reduction may result in "negative real estate" that will generate large losses in the future.
The End of the Depreciation Period and the Importance of Exit Strategies
The period during which depreciation can be recorded is finite, calculated based on the statutory useful life determined by the structure of the building. In particular, properties that can be depreciated to a large amount over a short period of time, such as used wooden properties, may appear to be highly tax-efficient, but the effect is not long-lasting. When the depreciation period ends, the expenses on the books decrease significantly, and in many cases, the real estate income suddenly becomes profitable and the tax burden increases.
Furthermore, a wrong exit strategy, or sale, can result in unexpectedly high taxes. Transfer income tax is imposed on the profit (transfer income) obtained from the sale of real estate, but this tax rate varies greatly depending on the period of ownership of the real estate.
| Period of ownership | Classification | Tax rate (total of income tax, inhabitant tax, and special income tax for reconstruction) |
|---|---|---|
| Less than 5 years | Short-term transfer income | 39.63% (tax rate for short-term transfer income) |
| Over 5 years | Long-term transfer income | 20.315% (20.315%) |
Change of mindset: Real estate is an "asset strategy for the family
We believe that real estate should not be viewed as a short-term tax-saving measure for individuals, but rather as a strategic tool for the long-term formation of assets for the entire family and their smooth transfer to the next generation.
From this perspective, real estate can be elevated from a mere investment to a "family asset" that stabilizes the family's livelihood, protects asset values from inflation, and passes on assets and feelings to the family members who matter most.
The Art of Using Real Estate as a Family Strategy
So, what exactly are the techniques? Here we introduce three typical methods. 1.
1. planned asset transfer through gifts during one's lifetime
This is a method of systematically gifting real estate to the next generation while you are still in good health in order to reduce the burden of inheritance tax in the future. There are various special systems for gift taxation, and by utilizing these systems, assets can be transferred while reducing the tax burden.
| Name of System | Outline | Advantages | Disadvantages |
|---|---|---|---|
| Calendar year gift | Gifts of up to 1.1 million yen per year are exempt from taxation. | Can be started from a small amount and continued over a long period of time with the expectation of significant tax savings | Gifts made within a certain period of time before the donor's death may be added to inherited property. |
| Inheritance-time settlement taxation system | Gifts of up to 25 million yen are exempt from gift tax, but at the time of inheritance, the gifted property is added to the inherited property and inheritance tax is calculated. | It is easy to transfer a large amount of property at once. If income-producing real estate is donated, the subsequent rental income belongs to the donee. | Once a donor chooses this option, he/she cannot return to calendar year gifting. Costs such as real estate acquisition tax and registration tax are incurred. |
2. flexible property management and succession through a family trust
A family trust is a contract whereby the owner (trustee) entrusts the management, operation, and disposition of property to a trusted family member (trustee). Family trusts are particularly effective in preparing for the risk of frozen assets due to dementia or other causes.
For example, if a real estate owner suffers from dementia, his/her bank account may be frozen and he/she may not be able to perform legal acts such as selling the property or making major repairs. However, if a family trust agreement is concluded in advance, the family members entrusted with the property can continue to flexibly manage the property in accordance with the owner's wishes. In addition, it is possible to specify in the trust agreement who and how the property will be passed on to after one's death, making it function like a last will and testament.
3. advanced asset protection through incorporation (asset management company)
If you own multiple income-producing properties or if your income exceeds a certain amount, incorporation is a viable option to establish an asset management company and make your real estate property owned by a corporation.
| Comparison Items | Individual ownership | Corporate ownership (asset management company) |
|---|---|---|
| Tax Rate | Progressive taxation (tax rate increases with income, up to 55%) | Corporate taxation (approximately constant once income exceeds a certain amount, in the range of about 30%) |
| Income Diversification | Not allowed | Income can be dispersed by having family members serve as executives and paying executive compensation, which may increase the take-home pay for the household as a whole. |
| Scope of expense recognition | Limited | Expenses such as life insurance premiums, retirement benefits, and rent for corporate housing for board members can be recognized as expenses. |
| Inheritance | Inherit the real estate itself (the assessed value tends to be higher) | Inheritance of the company's "shares" (stock valuation may be reduced by taking measures against stock price) |
Rather than earning real estate income as a sole proprietor, incorporation can be expected to offer various advantages, such as taking advantage of the difference in tax rates and expanding the scope of expenses. In addition, when an inheritance occurs, the company's shares, rather than the real estate itself, will be inherited, making it easier to divide the estate and prevent disputes.
Conclusion
Real estate ownership should not be judged solely from the short-term perspective of immediate "tax savings. It should be viewed as a long-term "family strategy" with an eye on your own and your family's future.
The tax-saving effect of depreciation is only temporary, and if you make a mistake in your exit strategy, you run the risk of incurring an even greater tax burden. On the other hand, real estate can be an irreplaceable "family asset" that continues to generate value for generations to come by combining techniques such as living wills, family trusts, and incorporation to create an optimal portfolio that matches your family structure and asset situation.
How can you best utilize the powerful tool that is real estate for your family? Why not consider it from a long-term perspective? We at INA&Associates K.K. will work closely with you to develop the best asset strategy for your individual situation. Please feel free to contact us.
Frequently Asked Questions
Q1: I am a beginner in real estate investment.
A1: Start by clarifying your asset situation and future life plan. After that, we recommend that you determine the purpose of your real estate investment (profit-making purpose, asset succession purpose, etc.) and consult with a trusted professional. It is wise to consider investments that can be started with a small amount of money or properties carefully selected by a specialist, rather than starting out with expensive properties.
Q2: Can I expect any tax savings at all?
A2: No, this is by no means the case. The mechanism by which losses from real estate income can be offset against other income is still an effective strategy. What is important is to understand that the tax-saving effect is not permanent, and to simulate the total cash flow, including the increased tax burden after the depreciation period ends and the transfer income tax at the time of sale.
Q3: At what asset size should I start considering a family trust or incorporation?
A3: There is no clear standard for a minimum asset size. For example, if you have at least one income-producing property other than your home and are concerned about freezing your assets due to dementia in the future, it is worth considering a family trust. As for incorporation, one guideline is that if your personal taxable income exceeds 8-10 million yen, the corporate tax rate is generally more favorable in many cases.
Q4: Which property is better, urban or rural?
A4: Each has its own advantages and disadvantages. Properties in central Tokyo have stable asset values and strong rental demand, but they tend to be more expensive and offer lower yields. On the other hand, properties in rural areas may be more affordable and offer higher yields, but carry a higher risk of vacancy and declining asset values than those in urban centers. It is important to choose according to your investment strategy and risk tolerance.
Q5: What can I do now to avoid disputes over inheritance?
A5: The most important thing is to clarify your asset situation and "how and to whom you want to bequeath your property" and to communicate this to your family. Then, making preparations in a legally effective manner, such as drafting a will, utilizing living wills, forming a family trust, and utilizing life insurance, will lead to an amicable succession of your assets.
Daisuke Inazawa
Representative Director of INA&Associates Inc. Based in Osaka, Tokyo, and Kanagawa, he is engaged in real estate sales, leasing, and management. He provides services based on his extensive experience in the real estate industry. Based on the philosophy that “human resources are a company's most important asset,” he places great importance on human resource development. He continues to take on the challenge of creating sustainable corporate value.
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