This Investor Paid Zero Out of Pocket for an $8M Apartment—Yes, Really

This Investor Paid Zero Out of Pocket for an $8M Apartment—Yes, Really

5 min read
Paul Moore

Paul Moore is the managing partner of Wellings Capital, a private equity real estate firm.

Experience

After college, Paul entered the management development track at Ford Motor Company in Detroit. After five years, he departed to start a staffing company with a partner. They scaled and sold the company to a publicly traded firm five years later.

After reaching financial independence at the age of 33 and a brief “retirement,” Paul began investing in real estate in 2000 to protect and grow his own wealth. He completed over 85 real estate investments and exits, appeared on HGTV’s House Hunters, rehabbed and managed dozens of rental properties, built a number of new homes, developed a subdivision, and started two successful online real estate marketing firms.

Three successful commercial developments, including assisting with the development of a Hyatt hotel and a very successful multifamily project in 2010, convinced him of the power of commercial real estate.

Press

Paul was a finalist for Ernst & Young’s Michigan Entrepreneur of the Year two years straight (1996 & 1997). Paul is the author of The Perfect Investment – Create Enduring Wealth from the Historic Shift to Multifamily Housing (2016) and has a forthcoming book on self-storage investing. Paul also co-hosts a wealth-building podcast called How to Lose Money and he’s been a featured guest on 150+ podcasts, including episode #285 of the BiggerPockets Podcast.

Education

Paul earned a B.S. in Petroleum Engineering from Marietta College (Magna Cum Laude 1986) and an M.B.A. from The Ohio State University (Magna Cum Laude 1988). Paul is a licensed real estate broker in the state of Virginia.

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WellingsCapital.com
Email [email protected]
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Twitter @PaulMooreInvest
How to Lose Money podcast

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Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your own attorney, CPA, and/or other advisor regarding your specific situation.

Love him or hate him, the Real Estate Investor-in-Chief in the Oval Office and his pals inside the Beltway have created more reasons than ever to be a real estate investor. In this simple post, I’m going to outline a straightforward strategy used by a real-life real estate investor who saved $2 million in taxes and landed a cash-flowing multifamily property in the process.

For the past two years, our real estate investor friend (we’ll call him Brett) has had a problem. Most people around the world would consider this a great problem to have.

We live in a wonderful country, and when a profit is made, we have a generous uncle who has his hand out to get his share.

It’s a blessing to make enough profit to owe Uncle Sam $2 million. But it’s a bigger blessing when you make the same profit and owe the IRS zero. That’s exactly what happened in our story.

Preparing for a Huge Tax Hit

For the past two years, Brett was setting aside funds to pay his large multi-million-dollar tax bill. But this year he conferred with a tax strategist who steered him in a different direction. The outcome was stunning.

USA: Traditional Uncle Sam Pointing At You

Do you have a tax strategist? It’s great to have a CPA, but make sure your CPA is a true tax strategist, who will coach you to maximize your deductions and minimize your taxes.

Several years ago, I told the story of Ed, who had been paying over $100,000 annually in taxes. After hiring a tax strategist, he has paid zero in taxes in the decade since.

(I’ve got a great tax strategist I recommend to investors. Reach out to me if you want to know more.)

Realizing the Enormous Benefits of Tax Reform

The tax strategist explained to Brett that under tax reform, Section 179 of the IRS code allows the immediate write-off of depreciation of “personal property” up to the 15-year level. This means that assets that are deemed to be depreciable in 15 years or less through a cost segregation study do not have to be taken in (say) 15 equal annual increments.

They can be used as a tax deduction in year one instead.

Related: Attention Multifamily Investors: Are you STILL Paying Taxes?

If this seems confusing, imagine you could take your tax deductions for the next 15 years and use them all this year. It could create a massive loss—and therefore, a significant tax savings this year. And the loss could be potentially carried over for years to come.

While a self-storage building has a 39-year life for depreciation purposes, the roof, parking lot, shrubberies, light fixtures, computers, gates, security systems, and many more items can be separated from the structure itself and depreciated in a shorter time. The new tax law may allow depreciation all in year one for many of these items.

Taking Full Advantage of Section 179—to the Tune of $2M

Brett is a really successful investor. It was the last quarter of 2018, and he had already set aside about $2 million of his profits to pay his whopping income tax bill due April 15, 2019.

Then Brett started thinking about what his tax strategist said. He realized that if he took that same $2 million and used it as a down payment on a new commercial real estate asset before the end of 2018, that same asset (with a cost segregation study) could generate up to about $2 million in tax write-offs.

Note that due to the role of leverage, he wouldn’t have to use all cash to buy the asset. With 75 percent debt, he could acquire an $8 million asset with this cash.

After factoring the (non-depreciable) land—say $1.2 million—out of the $8 million, the cost segregation study allowed the write-off of about 30 percent or so of the cost of the building (i.e., 30 percent of $6.8 million). This generated a year one write-off of about $2 million.

Related: THIS Major Tax Benefit Convinced Me to Put My Money Into Large Multifamilies

So, the $2 million that Brett had set aside for taxes was instead invested as equity in a new multifamily property. Brett’s bank account still had a debit of $2 million, but now he had invested it in his own cash-flowing, appreciating commercial real estate asset rather than in Uncle Sam’s coffers.

The very property he acquired provided the tax discount and equity he needed to buy that same property.

Too good to be true? Like I’ve said in other posts, if the American people really knew about the tax benefits available to commercial real estate investors, we’d have another tax revolt on our hands.

(Shh!)

Secret concept. Beautiful European female in eyewear, makes shush gesture, asks to keep voice down as suffers from headache, wears spectacles and striped t shirt, isolated over white background

Calling Attention to the Caveats

You knew there would be a catch, right?

First, please realize that I am not a tax professional. Like most of you, I’m a real estate investor and fund manager, who gets to enjoy these benefits. Please don’t take this as tax advice and call me to complain if it doesn’t work.

Second, realize that some of the benefits from accelerated depreciation are best utilized by investors who are designated “Qualified Real Estate Professionals.” In general, this means that you spend at least half of your time in real estate, and it needs to be 750-plus work hours annually.

(Note that some investors reportedly work closely with their spouses to be sure that at least one of them is a QREP.)

Conclusion and Recommendations

Maybe you don’t have a $2 million tax bill. But I’m guessing some of you readers have a $100,000 tax bill.

Will this work for you?

I don’t see why not. In this case, I would look to purchase a property in the range of $400,000 to make similar math work.

I’ve been recommending that a lot of real estate investors stay focused on their day jobs and invest passively in a syndication, for example. Will this work for you? I believe it will.

One of the beauties of the syndication model is that profits and losses flow from the project through the LLC(s) to the individual investor. This means that losses from depreciation (accelerated and regular) flow through to the K-1 of the passive real estate investor.

So, as a passive investor, I would apply this same math. But I still recommend that you check with your CPA or tax strategist to be sure this would work for you—especially if you’re not a QREP.

Non-QREPs still get the deductions, but they may not come as fast.

This is just one of many strategies that real estate investors employ to save on taxes and compound their wealth. By staying involved at BiggerPockets, you’ll hear about many more strategies and tactics, and you’ll meet other investors to guide you and cheer you along on your journey.

You’re in the right place to save on taxes and accelerate your wealth! Happy investing!

Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your own attorney, CPA, and/or other advisor regarding your specific situation.

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Have you used this or a similar strategy, or do you plan to this year? I’m always looking for real estate success and failure stories to feature in my blogs, on my BiggerPockets live events, on podcasts, and more. 

I would love to hear from you in a comment below.