However, what if we told you that the IRS could actually play a role in aiding your investment property journey? It's true, and understanding how can be the key to maximizing your returns.
Depreciation: The Silent Helper
One of the most significant ways the IRS can contribute to your investment property is through depreciation. This tax deduction allows you to recover the cost of an income-producing property by writing off its wear and tear over time. Essentially, it acknowledges that your property decreases in value as it ages and allows you to account for this on your taxes, thus reducing your taxable income.
Interest Deduction: Easing the Burden
If you've taken out a mortgage to purchase your investment property, the IRS allows you to deduct the interest on that loan. This is a substantial benefit since, in the early years of a mortgage, interest can make up a large portion of the monthly payment. Deducting this interest can significantly reduce your taxable income.
Tax Credits and Incentives: The Added Perks
The IRS occasionally offers tax credits and incentives for property investors—particularly for those who invest in areas that the government wants to develop or in rental properties that are affordable for lower-income tenants. Staying informed about these opportunities can lead to substantial savings.
1031 Exchange: Delaying the Inevitable
A 1031 exchange is a powerful tool provided by the IRS that allows investors to defer paying capital gains taxes on an investment property when it is sold, as long as another "like-kind" property is purchased with the profit gained from the sale. This can help investors to leverage their capital gains to scale up their investment portfolio.
Repair vs. Improvement: A Critical Distinction
Understanding the IRS rules on repairs versus improvements can have significant tax implications. Repairs are typically deductible in the year they are completed, while improvements must be depreciated over time. Knowing how to classify these expenses correctly can lead to immediate tax benefits.
Passive Activity Losses: Use Them Wisely
For some investors, the IRS offers the ability to use passive activity losses—like those from rental properties—to offset other passive income. While there are restrictions, particularly for those with higher incomes, these losses can sometimes be carried forward to offset future passive income, potentially reducing future tax burdens.
Make the IRS Work for You
As an investor, it's essential to be savvy about the tax implications of owning property. The IRS offers several avenues that can effectively contribute to your investment property, but it requires a proactive approach. Stay educated, consult with tax professionals, and make the most of the deductions and incentives available to you. With a strategic approach, the IRS can become an unlikely ally in your property investment journey.
Real estate investment property, if structured correctly, can actually be paid for with the tax savings from your entity structure. In other words, the IRS will pay up to about 50 to 60 percent of the cost of that investment if the investment structure is set up correctly. You do a cost segregation study, which I'll talk about in a moment, on the property, that allows us to do an asset allocation of all of the asset groups on the property.
We create a hybrid depreciation between straight line and makers depreciation, so that we're taking advantage of both modeling. And then the management fees that are paid out to the corporation eliminate and reduce taxes significantly. And basically your first 60 months of ownership are going to generate enough tax savings that the property, the cost of the property is going to be offset as much as about 60 percent depending on how much in that five and seven year asset group that we can stuff into that, uh, that part of the model again, this creates a vehicle for wealth accumulation and at the same time provides unique tax savings Now your ROI, your return on investment, both internal and external, or what we call inside and outside basis, your ROI on a typical deal that would be maybe 9 or 10 percent is actually now benchmarked 25 percent because you're taking the tax savings as an attribute to that And adding that part back to your ROI, and that's net dollars in your pocket.
That's a big deal. So let's go through some case studies. This is a purchase of four units about four years ago for $979,000. The direct tax savings between year one to four was 280, 000. It had an annual GSI gross scheduled income at the time of purchase of 70,000. Today it's at 118,800 because of a rent survey, which I'll talk about in a moment, and it has a current valuation of 1.8 million.
Next year will be the fifth year, so in 2024, this property will be debt-free. It will be positioned for a 10 31 of 2.2 million in value and equity. We're going to help assist in the structuring of the 1031. With no debt, 2. 2 million will acquire somewhere around a 10 to 12 unit property and the GSI will be 3x of 118 based on the modeling that we've done on the rent survey.
And we're going to be able to defer the taxes, and if you do this correctly, you can defer the taxes on this particular model until the day you die, and then take the tax bill to the grave with you, just put it in the coffin, and it goes to the grave with you if it's properly structured. This is what wealthy people do every day.
I've had the pleasure of working with mega, uber wealthy people, uh, over the last 20 years. That we come in and we help them put together these kinds of structures because it's in the tens of millions of dollars on big buildings. It's a big deal. A rent survey is very different than a rent comp. A rent survey takes an analysis approach as evaluation.
That's what I do as a CVA. And we look at the rentable square footage of the dwelling or the property, commercial or residential. We understand what the cost attributes are per square foot, what the rent is per square foot, what the tax benefits are per square foot, and then we model that out, and then we come up with a new hybrid.
In this particular case, it turned out to be much more advantageous to change all of the leases so that the tenants Got a fixed price and they didn't pay for anything. Water, sewer, gas, lights, trash, all of that was included in the price of the rent with the incentive that you won't get that big of a rent increase if you manage the use of the utilities.
And it turned out after year one, the actual utility cost in real dollars declined 18 percent in the first year. By year four, it was down 22%, and the rents increased 9 percent a year and moved up to 118, 800. When we get to year five on this property next year, it'll be 126, 700. That's the GSI. There's no debt.
It's accumulating a lot of cash, so it's going to go into the 1031 with a value of 2. 2 million and about 250, 000 in the bank. Cash accumulation will be important in the next three to five years as the market continues its contraction. And when we see this modeled out in a particular commercial property or a residential rental, we see an opportunity that is unlimited.
I mean, I've not seen this in the 40 years that I've been doing this. I've not seen an opportunity as great as we have right now. I wish I had another 40 years ahead of me. Probably not. But if I did, I know what I'd be doing. I'd be doing a lot more of this. The rent survey is a highly valuable analysis that unlocks the hidden value to any transaction, if it's a rental property or a commercial property.
And it's something that we've been doing for about eight, eight and a half, maybe nine years now. And for those clients that that Modeling has worked for it is you just generate a huge cash machine in that property that allows you to do a lot more things. Gives you more options and gives your client more options.
Contact us with any questions.
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