Commercial Investing regarding taxes

6 Replies

Another question I can't seem to find anything is. I know in the beginning of a loan you can just write off the interest because that's all your getting charged but later down the road you pay more down on principle so couldn't an investor lose money overall say if the principle is over the amount they can depreciate since investors typically use depreciation to offset the principle cost?

@Matthew Madrigal from a tax prospective, the longer you hold a property, the less and less advantages the taxes can be as the principle payments overcome the interest payments and the depreciation become completely exhausted. This is very apparent in properties that are held for 20 or more years and have been refinanced. I have seen properties that have a positive cash flow on a before tax basis but with almost no interest or depreciation to lower NOI on the tax returns, the taxes can be more than what the property is cash flowing on a before tax basis.

For Example:

Lets take a property that has fully exhausted it's depreciation and the mortgage is almost fully amortized. Let's also assume the properties NOI is $50,000 and the mortgage payment is $35,000. Let's also assume the interest payment of the mortgage is $5,000 with no other deductions (not even the 20% pass through deduction for simplicity). Lastly, let's assume the tax payer pays a 37% ordinary rate on every additional dollar they make. The math would look something like this.

BEFORE TAX CASH FLOW

NOI: $50,000

Mortgage : ($35,000)

Cash Flow : $15,000

AFTER TAX CASH FLOW

NOI: $50,000

Interest: ($5,000)

Taxable Income: $45,000

Tax Rate: 37%

Tax Liability: ($16,650)

Before Tax Cash Flow: $15,000

Tax Liability: ($16,650)

After Tax Cash Flow: ($1,650)

As you can see, in these circumstance, a before tax cash flow doesn't answer the entire story. So to answer your question, yes you can lose money but it would take some poor tax planning and investment management.

James Storey, CCIM

@Matthew Madrigal

If you have a 15 year mortgage - your mortgage interest deduction finishes up in 15 years
If you have a 30 year mortgage - your mortgage interest deduction finishes up in 30 years

If you have a commercial property - your depreciation will wrap up in 39 years.

So all things considered - you can see yourself with more taxable income after your interest / depreciation deduction finishes up. It is some conversations with your CPA to discuss ways you can get more deductions when those run up.

@Matthew Madrigal while deducting your mortgage interest is handy,  it should not be the only reason your investment works.  I submit to you that if you "need" mortgage interest or depreciation to make an investment function then it isn't an investment after all.  Remember the purpose here is to MAKE money, and when you do that, you owe taxes.  Yes there are ways to mitigate the excessive taxation that exists (through cost segregation, 1031 exchanges, other deductions and writeoffs), but the PURPOSE isn't about looking for write offs.  It is about making a return on your time and money... and sometimes you'll end up paying taxes.  Which is generally a better problem to have than losing all of your money on bad or over leveraged investments and not owing taxes because you are broke.

I'm with Allen on this one.  Your cash flow, which should be the reason you buy in the first place (unless you are a very big player), is better known as BTCF - before tax cash flow.  Think of the depreciation and expenses as a bonus that can change based on many things.

And remember, you may get emotionally attached to a property you've held for a long time but if you 1031 out of it you will LOVE the new found monies!

It's all relative to where the investor is at in life cycle and what their goals are. Some are wealth creation, some are wealth stabilization, and some are wealth preservation.

Someone who is 25 years old making 70,000 a year with net worth of 500,000 is different than someone who is a doctor making 1 million a year income with net worth of 20 million approaching retirement. One wants huge wealth growth and the other wants some wealth growth to outpace inflation and keep what they have safe.