Why Own Rental Property?
Why own rental property? Well, many people realize every April 15th that their house that they live in is also a great way to pay less taxes. After all, the interest on your home is tax deductible. But did you know that Congress has allowed tax codes for even better ways to save money on taxes by owning real estate?
Now then, before you only take my word for it, I am telling you something right up front. You should not make any financial decisions without contacting your accountant and attorney first. Let them tell you what their advice is. All I am doing here is letting you know what my family did to make millions of dollars.
Why own rental property? Would you be amazed to learn of a way to avoid a huge tax bill? Would you find it unbelievable if avoiding the huge tax bill also made you a hero to the community?
Why Own Rental Property – Sample Scenario
First, let’s look at the scenario we used in a simple format. Rental property is valued based upon the income that it generates. Many landlords are lazy. They don’t keep up their property. Thus, it doesn’t make the full income that it could. We would buy those properties. Then we would fix them up. After that, we would raise the rents to market value. This would raise the value of our rental property. We would refinance the rental property and pull out a good amount of cash. Sometimes even hundreds of thousands of dollars.
Now each year, the cost of living goes up and generally the rents go up as well. Yes, sometimes they go up as much as 10 percent or more. But let’s be conservative. For our example, let’s say the rents only go up 4% each year. Now obviously, if we fixed the property up and raised the rents, they may have gone up as much as 10 to 20% that year. But let’s just keep it simple and only say 4%.
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The Beauty of Depreciation
Next thing to consider is depreciation. Buildings will eventually fall to the ground. Granted, that may take hundreds of years, however the IRS allows us to depreciate as if it will crumble in 27.5 years. So, the IRS allows you to reduce your income that year as if you lost 3.64% of the value of your buildings.
So, let’s look at a simplified example. I am leaving some details out just to keep this post brief. I can give you more details if you want to have a conference.
Why Own Rental Property – the Numbers
I found a rental property that sold for $500,000. The land value was just under 33%. So, basically $335,000 was subject to depreciation. That came out to $12,182 per year.
At the end of 5 years the amount depreciated would be about $60,909. In addition, due to rents rising 4% per year, that building may be valued around $608,326.
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Thank You 1031!
Now, depending upon the marketplace, we would sell that property after anywhere from 3 to 7 years after we bought it. But we wouldn’t do a normal sale. We would do a 1031 tax deferred exchange. That would mean that we wouldn’t pay taxes on our capital gains now, but later when we sold the next property.
So, if we sold the property for $608,326, we would buy a more expensive property – say around $700,000. Again, what we would do is fix it up and raise the rents. But to keep things simple, we will look at only a 4% annual rent increase. So, we would write off around $14,840 per year in depreciation.
Let’s do it Again!
Again after 3 to 7 years, exchange into something else. Letting this one go for around $851,657, and doing an exchange into a property for around $950,000. Another 3 to 7 years, exchange from around $1,155,820 and into $1,300,000. Hold that until it’s around $1,581,649.
Now remember, during these years we did multiple refinances where we pulled out hundreds of thousands of dollars. That was where we took our profit.
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Why Own Rental Property – the Finish Line
At the end? We had done this so many times that for us we had a property that when we sold it, we would owe every penny
to the IRS. But instead, we donated it to a local hospital. We did this through a charitable remainder trust. By doing this, it meant paying nothing to the IRS. Even better? We still got to collect rents on that property for another 20 years after we donated it to the hospital.
Remember, these are just ballpark figures for illustration. You should consult your accountant and attorney before making any decisions.
The Bottom Line
But imagine investing $150,000, and over the course of the next 20 years, depreciating $340,000 off of your taxes, and pulling out hundreds of thousands of dollars through refinancing. Then because of a donation, not paying taxes on the gains. Even better, have a cash flow that continues for another 20 years.
Why own rental property? Because of the loopholes you can take advantage of – just like the folks that wrote those loopholes.
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