Tax Shelter

Tax shelter, especially when it comes to depreciation of real estate investment property, has more than one flavor to offer. Here’s an example of how to turbo charge results, using multiple strategies synergistically.


People talk about tax shelter. They understand that tax shelter means they’re going to pay less taxes. But, let’s really address how to use tax shelter in the best possible way with the best possible vehicle. When you’re talking about real estate, you really only have a couple choices when it comes to depreciation and depreciation, as briefly as I can make it, is a paper loss. What I mean by that is, you don’t really experience a loss of dollars out of your Levis, it’s a paper loss that the IRS accepts. What you’re doing is, you’re allowing for the slow disintegration through time of a physical building, theoretically anyway right?  What happens, when you chose to use something more powerful than normal depreciation, enhancing the amount of dollars per year that you’re getting (bigger shelter in other words), is because you make too much money and the IRS says you make too much money when you’re at a household income of $150,000 or more per year. Once that happens, it doesn’t matter how much depreciation you have left over, after sheltering the cash flow from your investment, you cannot use it against your ordinary job income. Therefore, it just sits on the shelf until you no longer own the property. This is where we can go out and plan to do just that. That you’re going to bank tax shelter, that you cannot use, because you make too much money. Meanwhile, what your other hand is doing is paying off the debt of that particular property as quickly as possible, usually a five year timeline, and the reason it’s a five year timeline is because after five years, and increased depreciation approach, as far as the dollars per year that you’re using with depreciation, falls of a cliff. So you want to get that thing paid off in about five years and the way you do it is, like I talk about many times, you’re combining many strategies. So you might use the cash flow from all your properties just to gang up on this one loan and you might have some note income and you use the after tax monthly payments to add to that elimination of debt on that one property. If you need a little bit more, and your family budget can stand it and you’re comfortable doing it, you can add a little bit of that. At the end of the five years, everything works as planned. What you have is a free and clear property that you bought just five years earlier. You sell it, and even if it’s gone up in value and you have a capital gain, let’s say you owe $10,000-$15,000 in capital gain, you’re probably going to owe another $15,000 in what they call depreciation recapture tax. Now the capital gains tax for the vast majority of investors is only 15%. Recapture tax is 25% so when you do this, you better be doing it on purpose and you better have a plan and you better be able to execute that plan when you want to. So here’s what happens: You get the sales proceeds from the sale of the property and let’s say, in this case, you have approximately $80,000 in unused depreciation. Well now the IRS can no longer bar you from using it against your ordinary income when you do your taxes for the year that you sold that property because you don’t own the property anymore. That means that that $80,000 goes against your income in one fell swoop. So let’s say, that year, you made $160,000. Before your accountant even breaks out the sharpened pencil, you don’t make $160,000, you make $80,000. Well if you live in a place like California, New Jersey, New York, Illinois, taxes are a little bit higher than usual, your state and federal tax savings are probably going to be at least a third which means, at $80,000, you’re going to save more than $25,000 in taxes that year alone. Well if your capital gains and recapture tax are, say $35,000 and you saved $28,000 by the fast forwarding of your unused depreciation in that year’s income taxes personally, you’re only paying $7,000 and you probably banked three or four hundred when you sold the property. Well that’s the happiest check you’ll ever right to the IRS; $7,000? So see, three or four hundred, 7,000. You’ll right that check every year as long as you can do it. So the idea is you do things on purpose. You combine multiple strategies and you get this kind of synergistic after tax result that you want to rinse and repeat and do over and over.

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