(NOTE: Want to learn how to flip houses to hedge funds? Click here for our “Partnering With Hedge Funds” special report.)
Editor’s Note: Dennis Fassett is a former corporate finance executive turned real estate investing “Cash Flow Mercenary.” Dennis specializes in single-family and multi-family cash flow properties and thoroughly enjoys assisting his fellow investors with their own strategies, including how to buy your first apartment building.
As an ongoing contributor to Mogul’s “Market News Updates,” Mr. Fassett provides us with his own unique, lively, and thought-provoking commentary on the timely industry news and events of today that are impacting our industry. And be sure to check out his other super-helpful Market News Updates. For now, enjoy...
From Dennis Fassett, Cash Flow Mercenary...
The subject of taxes is near and dear to my heart. Since I’ve had a day job for over 25 years, I’ve paid an absolute ton in taxes over the years. And seeing all that money taken away week in and week out all those years before it hit my bank account was infuriating.
And, notice I said it was infuriating. That is until I started real estate investing.
Now I have an MBA in finance, and I’ve taken more accounting classes than I’d care to admit. But it wasn’t until I started buying rentals that I learned the true power of a little thing called depreciation.
The IRS defines depreciation as:
“An income tax deduction that allows a taxpayer to recover the cost of property. It is an annual allowance for the wear and tear, deterioration, or obsolescence of the property.”
The best thing about it is that it’s a non-cash expense. That means you get to take the tax deduction even though you don’t lay out any cash.
Because of that, it’s become my favorite part of the tax code.
The great thing about it is that if you’re classified as a real estate professional, you can use depreciation-driven tax losses to offset day-job income.
How cool is that?!
Beware: One warning though – while I’ve taken a ton of accounting classes, I am by no means a CPA. So you MUST talk to a tax professional before trying this. Doing it wrong will attract the attention of the IRS. And they’re not folks you want to tangle with.
In the News..
With the subject of Trump’s depreciation-driven tax losses in the news, an article I saw about how he’s doing it caught my eye...
The author wrote that in any given year, a developer might be earning money from renting the property but reporting losses to the Internal Revenue Service because subtracting the costs of depreciation reduces income below zero.
With other investments, if it gains in value rather than depreciates, an investor will pay taxes on the increase in wealth once they sell the asset...
Real estate investors, however, are able to sell one property at a profit and purchase another one without paying taxes on the gains, a process that can be repeated over and over.
That means that an investor can expand their holdings, and their annual revenue, and defer taxes as their wealth accumulates. And in some cases, if an investor dies before paying, then the gains will never be taxed.
The author went on to explain that similar rules don’t apply to stocks. So when investors make money selling stocks, they generally can’t avoid paying taxes on the gain even if they put the money back into the market.
In addition, real estate investors typically borrow substantial amounts of money to finance their properties, and borrowers receive favorable treatment from the tax system. So not only can they deduct depreciation, they’re also able to deduct the cost of interest from their income every year.
That’s a benefit that’s not available to investors who pay cash up front.
An Expert Weighs In
The author quoted a person at a tax ‘think tank’ as saying that these exemptions make sense from an economic point of view. He said that because developers can exchange one property for another, it encourages them to continue investing, which benefits the economy overall...
He also pointed out that banks pay taxes on the interest they receive from real estate loans, and he argued there is no reason to tax the money twice.
He concluded by saying that these exemptions are available to firms in other industries as well, but the real estate sector benefits more because of its extensive reliance on debt.
I guess I shouldn’t be surprised that with all the class warfare chatter that was used in the campaign, that people are upset with Trump’s tax losses. But the fact is, he used the law as it’s intended – and enjoyed the benefits of playing by the rules.
I’m Listening
I’d love to hear your thoughts about this topic. Just keep it clean – this is about taxes and real estate – not politics. Share below.
Dennis Fassett
earned a BS in Economics and followed that up with an MBA in finance. After working and corporate finance and banking for several years, he started buying single family houses, and quickly built a very nice portfolio of cash flowing rentals. When the credit markets started to dry up and he couldn’t get any additional single family mortgages he shifted his focus to apartment buildings. He now has over $3 million in rental real estate. He manages most of it his self and still has a day job. Dennis has even created his own Private Equity fund to buy apartment buildings.