The most common reply I hear from folks calling me is, “I didn’t know that was possible.” Or something similar. It all goes back to the root of successful investing, which is doing things on Purpose — Purposeful Planning. One of the main factors in any Plan is how taxes/tax shelter blend into the big picture. Though you never wanna buy property solely for the tax benefits (VERY rare exceptions.), Incorporating them into your Plan with maximum impact is almost always a key factor in ultimate performance. (Think I sprained a finger typin’ that sentence. 
)
BawldGuy Axiom: In the long run the investor who doesn’t use all available strategies when creating and executing their Purposeful Plan pays a bigger price for inferior results.
The following are just a few of the questions to be answered when discussing taxes/tax shelter and real estate investing. First though, let’s agree on a layman’s definition of depreciation.
It’s what many call a ‘paper loss’ which allows for the aging and physical deterioration from usage, obsolescence, passage of time, or just simple wear and tear. There is no actual loss of money — which is why it’s commonly called a paper loss.
How do you assimilate the tax shelter aspects of investment into your Plan? Why can some folks ‘write off’ much of their job income while others are disallowed the same perk? What happens to depreciation I haven’t used? Have I lost it? How does tax shelter fit into the big picture as it relates to my retirement? What happens to depreciation when I sell or exchange the property? Why is there a tax on tax shelter? Are ya makin’ that up?! What is ‘cost segregation’?
Let’s deal with one or two of the above questions.
The integration of tax shelter into your Purposeful Plan is far more important than most realize. Common wisdom says investment real estate comes with X amount of depreciation, which will ‘give them’ some annual tax shelter — in other words they’ll pay less taxes. True enough as far as it goes, but for the serious investor it barely scratches the surface of what’s possible.
First thing outa da box is the answer to the question — Are ya going for capital growth or cash flow? The strategies are hugely different depending upon your answer. Sometimes investors realize, sadly after the fact, that their ‘really cool’ cash flowing property doesn’t have enough tax shelter to keep most of the cash flow out of the rain so to speak. High cash flow properties are, in many instances, the punch line to a good news/bad news joke.
The good news? Whoopee! There’s a boatload of cash flow. The bad news? Uh oh, there’s a boatload of taxable cash flow. Oops. The problem was avoidable in most cases if PLANNED for in advance using the tools available. Fortunately for those finding themselves in that position, I can come in after the fact and show you how to shelter all that cash flow so it can stay in your pocket instead of so much being diverted to your favorite Uncle.
What about when capital growth is the agenda? The same principle of Planning applies, just a different section of the playbook, commonly called the Internal Revenue Code. Since yer gonna get tax shelter from income properties whether ya want it or not, ya might as well use to to maximize its benefits to your side of the table, right?
You must first assess your family’s job income — is it over or under $100,000 a year? If it’s appreciably more, you take the left fork in the road. If it’s less ya take the right fork. Betcha didn’t know that. The IRC discriminates against earners making more than six figures at work. They won’t even allow you in the depreciation club when your income exceeds $150,000 annually. The paradox is however, that even if you earn over the magic amount, in my experience yer almost better off in the long run.
I’ve written about it here a few times before. Here are a few things you have at your disposal as it relates to depreciation — what you should know.
1. Understand — a property’s depreciation first covers any cash flow. Only then, if there’s any left can it be used to offset some of your job (ordinary) income, subject to the above mentioned limitations.
2. Regardless of how much depreciation you have? Only $25,000 a year can be used against your job income. Many investors are unaware of that little gem until their CPA explains it to them on their first tax return. Brutal discovery.
3. Unused depreciation doesn’t disappear. It can be used to offset a capital gain in some future year. Yep, ya might even be able to avoid a tax deferred exchange if there’s enough of the stuff accumulated. Pretty cool, eh?
4. Caveat — when ya sell, the universal law saying ‘Whatever the IRS gives, it eventually takes away’ applies just as mean spiritedly to ‘used deprecation’ as it does to a capital gain. Just so ya know. In fact, it’s taxed at a higher rate. Hence, the use of IRC Section 1031 to defer said tax. (Unless you executed #3 )
5. An investor can include in his Plan the ability to sell a significantly high equity property around retirement time without paying taxes. No, really, ya can. But it’s gotta be on Purpose. Nothin’ like grabbin’ a quick million bucks or so at retirement.
See a trend developing here?
Seriously, I’m merely uncovering a few layers of what’s possible for you when you incorporate Purposeful Planning as you invest for retirement. It’s akin to what Grandpa told me about fishin’. “Ya can’t catch any trout son, if ya don’t know where they are.”
Knowing all the tools available to you while setting up a long term Purposeful Plan for real estate investment almost always turns out to be THE difference.
Call me at 619 889-7100 so we can chat about your Plan. Have a good one.
Related posts:
- A Real Estate Investment Strategy For the Times
- The Facts About a Strategy For Offsetting Capital Gains – Not To Mention Steering Clear of Taxes
- Buying And Holding — Real Estate Strategy Leading To Unintended Consequences
- How Can San Diego Real Estate Investors Improve Their Current Strategy?
- Purposeful Planning And Tax Shelter For Real Estate Investing
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