Although most people think of real estate as being homes, retail centers, apartment buildings or offices, in fact the true definition of real estate is in the land that underlies those buildings. Although vacant land typically does not convey the cash-flow benefits of improved property, it nevertheless offers a number of tax benefits as well as the ability to enjoy the long-term potential for appreciation that many pieces of real estate enjoy.
Writing Off Expenses
Just about every expense, including property taxes and mortgage interest, that you incur in owning land can be written off on your Schedule E, where you can use it to offset income you receive from renting out your vacant land or income from any other real estate that you own. If you do not have any other real estate, you can carry forward those losses for use in future years when you do have real estate income.
Most people buy land to benefit from long-term appreciation. Because no money changes hands until you actually sell your land, no taxes are subtracted from any yearly growth in its value. This keeps all of your capital working and growing for you until you are ready to actually pull it out.
The IRS subjects the sale of most investments to capital gains taxes. So, for instance, if you sell 100 shares of IBM to buy 100 shares of Apple, you would pay — at the time of publication — 15 percent federal capital gains tax, as well as state income tax on any appreciation in the value of your shares of IBM. With vacant land, if you are selling it to buy additional investment real estate, you can do a 1031 tax-deferred exchange. This mechanism allows you to invest all of your equity into the replacement property, while carrying your tax basis forward. You do not have to pay capital gains tax on the sale, though.