What You Need to Know Before Buying An Investment Property in Florida
Owning investment property is a great way to build generational wealth for yourself and your family, but it does come with additional responsibilities. Florida is an attractive destination to own a second home or rental property because it has no state income taxes and has a desirable climate.
Despite no state income taxes, if you make money from renting or selling a Florida property, you may need to pay federal income taxes on the profit. Additionally, you will pay annual property taxes on the value of the property, and you may be subject to paying income taxes in your state of residency.
Before you jump into owning an investment property in Florida, consider these five things.
Foreign Sellers and FIRPTA
If you are a foreign investor who is selling your Florida investment property, you must comply with the Federal Investment in Real Property Tax Act (FIRPTA). FIRPTA is not a tax but rather a law that helps ensure that foreign sellers pay federal capital gains tax, and FIRPTA requires that the buyer withholds up to 15% of the amount realized from the sale of the property to ensure the foreign seller pays the federal capital gains tax.
It is possible for foreign sellers to obtain a Withholding Certificate from the Internal Revenue Service (IRS). You can learn more about FIRPTA and its exemptions here. Because the process can be complex, we recommend that you meet with a real estate tax expert to navigate the process.
Answer more frequently asked FIRPTA questions on the SMART Blog!
Reinvestment and 1031 Exchange
Although selling your investment property does not qualify for a tax reduction under the Taxpayer Relief Act of 1997, you may be able to defer federal capital gains taxes if you reinvest in another property. A 1031 Exchange or 1031X (formerly called the Internal Revenue Code (IRC) Section 1031 outlines how a seller can defer some or all federal capital gains taxes when the profits of the sale are immediately reinvested in a like-kind property. With this being a federal tax code, the 1031 Exchange can be applied to properties from one state to another, but it does not apply to foreign properties. It is important to remember that 1031 is a tax deferment and not a tax credit or tax reduction. If you continue to sell properties and roll the profit into the replacement property, the tax will continue to be deferred. But upon selling the final property, you will owe the original deferred amount plus the gain from the sale of the last property.
The 1031 Exchange timeline for finding and closing on the replacement property is strict. You cannot take possession of the sale proceeds at any time. You are required to use a Qualified Intermediary (QI) to place the cash in escrow and ensure the accurate timing of proceed exchange. One uncommon exception of this process is a “direct swap,” in which the money changes hands the same day as the closing of the replacement property; however, even the tiniest error can disqualify the buyer and require that they pay the capital gains taxes.
Unlike many financial industries, the QI industry is not regulated. Because the QI plays such a pivotal role in the 1031 Exchange, it is critical that you find a reputable QI. The QI will do the following on your behalf:
- Facilitate the 1031 Exchange agreement and sale of your property;
- Hold your funds in escrow;
- Purchase the replacement property; and
- Transfer the replacement property to you.
As always, we recommend that you seek tax and legal advice to ensure you are addressing your unique tax situation. Your tax professional can oversee this complicated transaction and help you find a trusted QI.
Note: Foreign sellers subject to FIRPTA withholding may participate in a 1031 Exchange if they are eligible.
Florida State Property Taxes
In the state of Florida, both residents and non-residents pay the same property tax rate. However, Florida residents may be eligible for a Homestead Tax Exemption on their primary residence in Florida (or that of their dependents), and such an exemption can reduce the property’s taxable value by as much as $50,000.
In addition to the Homestead Exemption, Florida residents are protected by the Save Our Homes (SOH) Amendments, capping increases in a property’s assessed value at 3% annually. Both of these programs can significantly decrease an owner’s property tax liability, especially when compared to an out-of-state owner or non-primary resident owner.
Short-Term Rental Laws
The state of Florida does not allow local governments to entirely prohibit short-term rentals or regulate frequency of stays or stay lengths. This law was passed in 2011, and local short-term laws that were passed before June 1, 2022, can remain in place.
However, local governments are allowed to pass rules that control the negative effects of vacation rental properties in their localities. In recent years, local Florida governments have actively attempted to regulate short-term rentals.
If you plan to purchase a property with the intention of renting it out as a vacation home, work with a Florida real estate attorney to understand all of your restrictions before making the investment.
Location
Florida overall is a strong market, but location is extremely important for an investment property. Ensure your financial goal with this purchase is clear so you can search for properties that help you meet your goal. For example, your approach for purchasing a short-term vacation rental is different from your approach for buying a long-term rental in an up-and-coming mid-size city. Location is also important in terms of cost. Homeowners Association fees and local lodging taxes can affect your costs and the costs of your renters.
DISCLAIMER: The information gathered here is deemed reliable as of the date of publication, but each aforementioned agency has the right to change its information and processes. We strongly recommend that you meet with a Florida Tax Accountant and Real Estate Attorney before making a purchase. For additional information on this topic contact Evelyn Miller, Partner, at 202-753-7400.
