5 KEY ASPECTS TO EVALUATING INVESTMENT PROPERTIES PRO-FORMA (PART 2 – TAX BENEFITS)
September 23, 2014 By Larry Arth
Today we are going to be talking about what might seem like the most boring part of the pro-forma review, Tax Benefits.
Now, if this really does sound boring to you, (and understandably so) you may be missing a great wealth building principal. Getting your tax liabilities reduced is paramount to building wealth. Most people (myself included) always shy away from this boring topic, until I learned that the wealthiest people are able to maintain their wealth because they are not giving all their money away.
After all, why bother investing if you do not plan to keep your money. If you have not had a chance yet, please read the post, You Cannot Create Wealth In Real Estate Until You Gain Control of Your Taxes.
Money Saved Is Money Earned
Our last post was about the first wealth building principal of INCOME and how to truly evaluate cash flow. Now let’s advance to the second wealth building principal:
Deductions: The ability to deduct many items from your reported income so that you can reduce your tax liability. When you show that you made (let’s keep it simple) $100,000 and you are in the (let’s say) 25% tax bracket, you will owe 25% of that income to taxes or $25,000. Now, what if you were able to create (legal) tax deductions and reduce that tax liability down? You can do that through the many allowable tax deductions. On investment property you can deduct things like
· Interest payments on the mortgage
· Repairs to the property
· Purchases on things like appliances
· Anything you hire done as a service to the properties
Lets Take a Closer Look at the Depreciation
OK bear with me, boring perhaps but a very valuable benefit! As an incentive to investors like you, the government created an incentive to investors to help create housing for those who cannot afford to (or desired to) own a home. This incentive is a depreciation deduction. Now we all know that real estate actually appreciates in value. However, for this incentive the government looks at the investment as a depreciating asset.
This can get complicated, but to keep things simple for this illustration, the government allows you the investor to deduct the value of your residential investment property over the course of 27.5 years. Or basically 27.5 years equates to 3.63 % of the value of the property each year as a deduction. Think about it like this, for a $100,000 property at 3.63% the deduction per year is in and of itself a $3,360 tax deduction for this one line item of depreciation. Now imagine if you had 10 of these $100,000 properties you would have a $33,600 dollar deduction.
As you can expect, the IRS never makes taxes simple, but I wanted to give you the basics. When it comes to taxes everyone wants to check with their personal tax advisor for clarity as to how it may impact you. For you information junkies like myself I have a great illustration (with examples) and deeper details for you to look at here:
Now, add in all the mortgage deductions as well as any repairs you have done along with all miscellaneous expenses and you will have yourself a nice set of deductions to offset your initial taxable income.
The Invisible Wealth Creator
When you do not see money coming to you in the form of cash or a check you tend to not give it any attention. I invite you to dig deep into this subject, as the wealthiest real estate investors understand that money they do not have to pay in to the IRS for taxes is one of their wealth building principles and is as good as money in the bank. Look at it this way, for every dollar you do not have to pay in, is money you have to reinvest for more property, providing yet further leverage for your investment portfolio.
Next post we’ll look at the equity and appreciation of the investment portfolio.