Real Estate Investing Tax Benefits for Investment Property Owners – Video
Kathy Fettke: What kind of tax breaks can you get as a real estate investor? It’s really just incredible. When you own investment property, you can deduct the mortgage interest, the property taxes, insurance, maintenance, repairs, professional fees, education, and even travel. Again, talk to your CPA. We have a wonderful list of CPAs that understand which deductions that you can take and what you can’t take. Don’t take my word for it, just talk to them to see what applies to you and ask about all these things.
Depreciation means that you can write off the house as if it were worth nothing in 27.5 years. It’s very strange, but that’s how the tax law is written in regards to depreciation. Basically, the way it works is you take 80% of the value, which is basically the structure, the property, not the land. The government won’t let you depreciate land because they don’t see that as wearing out, but they see the house as wearing out. Of course, many of us live in homes that are much older than 27.5 years, so it’s really not true that a house wears off in 27.5 years. For example, Rich and I just bought a house in Malibu that was built in 1925. Of course, it really looks like it was built in 1925, but hey, it’s Malibu.
Houses can obviously last longer than 27.5 years, but you get to depreciate it this way. The 80% of the value, unless you’re in California – they might consider the land value higher than that, but in most of the country, this is the general rule that works. So, in other words, you take 80% of the value of the structure and divide it by 27.5 years. If you bought $100,000 worth of property where the land might be worth $20,000, you times it by 8. That’s $80,000 divided by 27.5 years. That’s $2909 annual deduction that you get to take for that.
Again, talk to your CPA because if you can get too much money, you can’t necessarily take these deductions this year, but you can take them eventually. Again, that’s not my specialty, but it’s something to bring to your CPA to discuss, but make sure your CPA understands the real estate. I’ve had so many people come to us at RealWealth saying, “You know that my CPA said this or that,” and we were scratching our heads thinking that, again, I’m not a CPA, but that doesn’t sound very true. Not every accountant is an expert in everything. You always want to pick an accountant who is an expert in the thing that you’re doing.
If you were a business owner, you would probably want an accountant who really understands the deductions you can take from business, but if you’re a real estate investor, you really need to work with an accountant who understands all the deductions that you can get as a real estate investor. Even better yet, if that accountant invests in real estate also, then they’re really going to know the tax breaks because they’re obviously using them themselves.
A 1031 exchange is a way to defer the capital gain. I’ll just give a recent example, somebody who just sold their condo in Mountain View for, I don’t know, $1 million or something like that, and they had paid $500,000 for it years ago. Of course, the San Francisco Bay Area does that kind of thing, and the gains are pretty incredible. If you were to just sell the property, you’d have a $500,000 gain.
If it were an investment property, well you have to pay capital gains on that which could put you in the 20% category. That’s a sizable amount of money—$100,000—but if you did a 1031 exchange, you could just defer the capital gain, so you don’t have to pay it until later. You’d then have and buy a million dollars worth of property elsewhere, but I just showed you how you could do that buying 10 houses somewhere else.
I’m a huge fan of the 1031 exchange because I can’t stand to see people in the San Francisco Bay Area, or other high-priced markets, where they have so much invested in one property. It’s not diversified, and that’s not a good idea in my opinion. For example: if you own a property, let’s say, in San Francisco worth $1 million and you have $500,000 worth of equity in it, and let’s say, there’s an earthquake. Well, you’re not going to have any income for a while, and you’re going to have to wait for your insurance to pay you back. What if it’s a bad earthquake? Now, that one property is in trouble.
What if you had exchanged it for 10 properties that are in different parts of the country? Let’s say there was a natural disaster in one of the areas where you invested in one of your homes. They got damaged and you’re not getting income from that, you have nine other homes in other areas that it’s not really going to affect you too much. You just have one home that’s not paying you. So I am really encouraging people to diversify, diversify, diversify. Do not have your nest egg in one basket, in a high price market. It’s just not wise. It’s not wise not to be diversified anywhere.
I have friends who have all of their retirement as stock options in the one company they work for, and I had someone else I talked to this morning who had all of her money in Apple. It’s just risky. It’s risky. It’s the same thing with property. The 1031 exchange is an opportunity for investors to be able to do something different and not have to play the game at that time, it just gets pushed off later until you die. If you still have those properties and you die, then your children or whoever inherits those properties, benefit because it steps up to current market value, and they don’t have to pay the gain.
That’s part of law. That can always change, but the 1031 exchange is just a really wonderful opportunity especially for those of you who love timing markets. One of our own staff members, I won’t mention who but many of you already know, just sold his property in the East Bay and had six or seven or eight offers and many of them were way over asking price. So, he timed selling his property beautifully, and now he is buying elsewhere – in a market that is not at the peak of the market. If you like selling at the peak and buying at the trough, now is the time. You can sell your high-priced property that we know is in a bubble right now and exchange it, tax-deferred, for properties that are just at the beginning of their boom cycle. Really, really great opportunity.
You can also buy real estate within your IRA. This is such a common misconception that you can’t or that you have to take the money out of your IRA and pay penalties or borrow from the IRA and pay interest back, and have it paid back in five years or whatever. Anyway, there all sorts of ideas about this, but if you go into your financial planner’s office and say you’d like to invest in real estate, they’ll look at you and say, “You can’t do that.” They’re right. You can’t do that with certain brokerages who don’t invest in real estate.
If you’re going to your broker and saying, “I want to buy real estate,” again they will say, “We can’t do that,” because they are a brokerage firm, because they only invest in the stock market or REITs or whatever. If you really want to invest your IRA in real estate, you have to self-direct it. You have to take it out of that brokerage house and into a custodian who will allow this. You could do it with your 401(k) which is really a great option for your real estate, but basically, you can self-direct it. We have five or six out IRA companies we recommend. You could talk to all of them, compare fees and rates, and you could talk to members on the network who’ve done it. I’ve done it. It’s very common to do and not difficult at all.
You just talk to the custodian, and they do it actually all for you. Then you can buy real estate, or I should say your IRA can buy real estate. You are not supposed to have anything to do with it, just your IRA, but you can direct your IRA and your IRA buy real estate, buy and hold real estate or notes, and then all the game just goes right back into your IRA. If you sell that property or the cash flow goes right back into your IRA. You could even get financing. Your IRA can get financing so that it can buy more real estate. Again, common misconceptions there but absolutely legal and we do it all the time.