Tax-Free Wealth Through REI

One of the great benefits of cash flow real estate is the ability to create tax-free income. It is said that if you want to see what the government wants its people to do most, look at the tax code’s incentives. With all of the tax advantages associated with real estate, it is very clear the US government is very desirous of entrepreneurs and investors to focus on providing quality, affordable housing in America. Let’s dive into some of the big tactics which allow an investor to fully utilize these tax incentives.

First, let’s look at an apartment building’s cash flow as an example. Our example apartment building has $500,000 in net operating income (NOI). Without proper tax strategies, this income would be taxed fully. However, the interest portion ($250,000 in our example) of the mortgage payment for the property can be written off against the income of the property. Now we are left with $250,000 as our reported income. Great, but hold on, our goal is to get our reported income down to $0! So let’s keep going.

The next powerful tax strategy is depreciation. The IRS views this apartment building as a tool for business just like a tractor is for a farm business. Both our building and a tractor have a finite life span. To accommodate for the gradual wear and tear of the property, the IRS allows an investor to write off a portion of the building’s value each year. The IRS chose 27.5 years as the depreciable lifespan of a residential building and 39 years for commercial buildings such as retail and office. So assuming a cap rate of around 7%, our example property is worth $7,000,000. The actual building’s value (not including the land) is 75% of the price, or $5,250,000. $5,250,000 divided by 27.5 years means each year, we can deduct $191,000 annually from our income. Now our stated income of $250,000 becomes $59,000. Not bad right? But we want $0, so let’s keep going. This depreciation strategy I just explained is actually the lazy man’s way of tax planning. The legal and more sophisticated way to actually calculate the appropriate depreciation for an investment property is through a more advanced tactic called cost-segregated depreciation. This requires hiring engineers to inspect your building in order to more accurately assess the wear and tear occurring to the property. Through cost segregation, the $5,250,000 of building value can now be depreciated over a seven year schedule. This means we can deduct $750,000 per year in stated income! Wow, we did it, we brought down our initial number of $500,000 of NOI to $0 of reportable income. Not only that, we are actually reporting a loss to the IRS which allows us to offset any other potential passive gains from other entrepreneurial and investing activities. And we were able to achieve our goal of paying no taxes without other advanced tax strategies such as de minimis safe harbor election. Hopefully you find this information helpful as you progress on your road to financial freedom.

To learn more, visit my website www.menloathertondevelopments.com.

Email: [email protected]

Phone: (650)-380-2609