Wednesday, May 3, 2017

How I invested in real estate - real life success story

One of my favorite ways to reduce my tax burden is to invest in real estate. I’ve known many people who work in the E Quadrant but invest in real estate, which puts them into the I Quadrant. In the process, they eliminate a lot of tax burden and enjoy substantial cash flow. Many of these folks have gone on to simply invest full time in real estate.

Here's a real-life situation in which I played by the rules of the rich and minimized my taxes through rental property:

-    2004: My wife, Kim, and I put $100,000 down to purchase 10 condominiums in Scottsdale, Ariz. The developer paid us $20,000 a year to use these 10 units as sales models. So we received a 20 percent cash-on-cash return, on which we paid very little in taxes because the income was offset by the depreciation of the building and the furniture used in the models. It looked like we were losing money when we were in fact making money.

-    2005: Since the real estate market was so hot, the 380-unit condo project sold out early. Our 10 models were the last to go. We made approximately $100,000 in capital gains per unit. We put the $1 million into a 1031 tax-deferred exchange. We legally paid no taxes on our million dollars of capital gains.

-    2005: With that money, we purchased a 350-unit apartment house in Tucson, Ariz. The building was poorly managed and filled with bad tenants who had driven out the good tenants. It also needed repairs. We took out a construction loan and shut the building down, which moved the bad tenants out. Once the rehab was complete, we moved good tenants in and raised the rents.

-    2007: With the increased rents, the property was reappraised and we borrowed against our equity, which was about $1.2 million tax-free, because it was a loan—a loan that our new tenants pay for. Even with the loan, the property still pays us approximately $100,000 a year in positive cash flow.

Of the tax benefits that come with real estate investing, you can also include phantom income. Simply put, phantom income comes from things like depreciation, which means that a set portion of my property value is deducted from my taxable income each year to account for value loss as the property ages. This lowers your tax burden but isn’t a real out of pocket cost. Thus, phantom income.

As I mentioned in the example above, you can also pull money through a refinance out of your property and make money tax-free. If you do this correctly, the income from the property pays for the excess debt service. You can then use that money to invest in more property. It’s a virtuous cycle.

Also, as with any business, you can deduct a lot of expenses through your investment activities.

Those are just a few ways investing in rental property can help you reduce your tax burden. There are many more. If you’re interested, I suggest you do a deep dive and learn.