Pay no taxes? I’m listening.

13 Replies

I’ve been in realestate investing for over 10 years. I continually hear people talk about “paying no taxes” being a benefit to owning realestate, but I’ve yet to have heard a single explanation of how that’s possible if you’re making a profit. Properties have no mortgages and all have great returns.

Someone please, let’s hear a comprehensive explanation of how you make a profit and don’t pay any tax.

@Jeff Cantrell

Most commonly, It’s mixing of words and definitions between cash flow, profit, and income.

You can have positive cash flow but after non-cash expenses (depreciation and amortization), you won’t have to pay taxes because your depreciation expense wipes out the positive income you would have had. Negative income (ie loss) means no taxes on your schedule e for that property.

You buy a $200k townhome that you own from the studs in (so that it’s 100% depreciable for simplicity’s sake.)

20% down 4% interest in 30 year $160k loan is $765 of which approximately $535/mo ($6420/year) is interest. Insurance is say $750/year and property taxes are $2,000/year.

 you get $1250/mo rent ($15k/year)

So you have $15k minus $6420 minus $750 minus $2,000 = $5830 “profit” and $3,070 cashflow. 

But, you get $200,000 / 27.5 years in depreciation. $7272/year. So the IRS say your profit is $5830 minus $7272 or a loss of $1442, so you pay negative taxes (a credit) which is  even better than zero taxes. Even though you put $3,000 in your pocket. 

@Bill Brandt

Thank you for the well thought out response.

Your numbers:

20% down 4% interest in 30 year $160k loan is $765 of which approximately $535/mo ($6420/year) is interest. Insurance is say $750/year and property taxes are $2,000/year.

;you get $1250/mo rent ($15k/year)

With those numbers, that’s only around 6.25% return, so it would be easy to make that a loss. In my area, the numbers would look more like:

200k property

160k loan

$1400 property tax

$2000/month rent ($19,200 assuming 20% expenses)

So, a 9.6% return (reasonable but still not great)

$19,200 (estimated income after expenses of 20%)



-7272.00 depreciation

=$5508 profit.

No way around that is there?

Also, now look at it with no mortgage. Now you’re at a profit of $11,928.

So if your buying cash, are there any provisions in tax law to not pay on the entire income? Because people like to make it sound that way, but can never give an example or explanation.

@Ryan Chatman 27.5 years is the number the irs picked out of thin air for how long residential real estate would last. So that’s the number you divide by. 

@Jeff Cantrell  you’re letting the tax tail wag the dog. 

Look at your example. You’re complaining about paying tax on $11,928 while earning ($11928+$6420=$18328) if you paid cash. But you’re giving up buying 5 properties instead with the same $200k and making 5 x $12,780 ($63,900). You can’t give $45k in profit to complain about paying taxes on $11,928.

I’m sorry you’re collecting too much rent as a percent of purchase price. A closer example in Las Vegas looks like this. 

$300k purchase, $1800 rent $2400 property tax $700 insurance 

Means $240k loan or $1145 payment and  $793 interest

$21,600 rent minus 20% expenses = $17280 income

$17,280 minus $9516 interest, $2400 property taxes, $700 insurance = $4664 minus $10,909 depreciation - a loss of $6245. 

Even if I add back in your 20% in expenses and say we didn’t use property manager, you didn’t write off your cell phone, your internet, your new iPad, and nothing broke you have a $2,000 loss. 

If your only intention is to show a loss buy in appreciating markets where all the real money will be made in appreciation. Way more than half of my annual net worth increases are from appreciation not rent. That’s what pushes your returns to 20 or 30% all while being taxed on 5% in your example. 

Right now our tax rates are at historic lows, pushing off taxes until the government really needs the money probably isn’t ideal. 

Ps. A year or two later you pull out your 20% down with a cash out refi and your returns are infinite while you lower your taxes. Win win. 

@Bill Brandt

I don’t disagree with anything you’ve said.

Realestate has always been a secondary business (investment vehicle) for me and always cash purchases, which is what my original question pertains to. I should have been more clear.

Is there any way, without taking on debt and more properties (not that doing so is a bad thing) to avoid taxes? The only methods I can seem to find is opportunity zones.

And again, I am not opposed to using leverage, it’s just not what I’m asking about. If the right, large deal were to come along, I would consider leveraging our portfolio to make it happen.

Also, like you, a large portion of our net worth has been from appreciation, even while making really great ROIs.

Appreciate your input.

@Jeff Cantrell Plenty of investors pay lots of taxes.

When you are a small investor with heavy expenses or you are accelerating depreciation, you can avoid taxes for a while. When accelerating, you are trading early year losses for later year gains. You are only paying no taxes if your business expenses outweigh your income. That is hard to do with a successful business over longer periods of time. 

Depreciation is a business expense (like others) and despite what people say, it is not a gift or blessing. Structure depreciation is simply the value of your structure split out over 27.5 years. I purchased a house for $230K last year. Structure value is $200K, which is $7272 per year or $606 per month. Rent is $1650 per month, so depreciation alone doesn't shield the property from taxes. Even after subtracting mortgage interest, property taxes and insurance, I am still making a profit at the end of the year. 

The other thing to remember about depreciation is that it is recaptured at the time of sale. It is deferring taxes, not avoiding taxes. I know people will quickly say that they plan to 1031 forever, then die and leave the property to their children at stepped up basis. That sounds good, but people don't understand that a 1031 transfers basis. That means "used up" depreciation is transferred to the new property. This means less and less depreciation to offset income. You will have to keep trading up to larger properties. It sounds good when you are 30 years old, but when you are 80 years old are you really going to be buying 1000 unit apartment complex? Eventually the depreciation just can't offset income, so you pay taxes. Then you sell and pay recapture taxes. I also hate to be the bearer of bad news, but the likelihood that a 30 year old today will be able to transfer wealth at stepped up basis is near zero percent. Tax laws get more progressive over time and in 50 years, you will likely be taxed for even holding equity.

You can definitely use some strategies to reduce taxes. Bonus depreciation, transferring regular expenses to business expenses and relying on repairs more than capital improvements are good strategies. 

If you start paying off properties and lose mortgage interest deduction, it quickly becomes hard to to not show a tax profit.

@Jeff Cantrell It is really about how well your non-cash period expenses are maximized. Most users on here already mentioned depreciation and amortization, that is the best example of noncash expenses. 

A cash out refinance to implement the mortgage interest (which is deductible) will provide another expense but is certainly a cash transaction so dollars leave your pocket for that deduction.

@Brian Walters

I don’t have a real clear answer for that Brian.

I suppose I would if I found/create the right deal, but I haven’t found anything as of late.

Some of it is personal comfort level. We’ve built up relatively slowly and learned along the way and we’ve now gotten to a level where we’d be more comfortable taking on a bigger risk, so it’s really about making the right deal.

We just bought an additional 5 SFH last month but didn't need the cash. We missed out on a bigger deal earlier in the year, that would have required some leverage, because we couldn't come together on terms with the seller.

I’m patient and the right deals will come along in time.

the great thing with real estate is that the IRS gives you an annual deduction called depreciation which is a non-cash tax expense.

The second thing is timing of expenses, the IRS may allow you to accelerate many expenses in earlier years as opposed to over a longer period of time.

The third is that many taxpayers miss out of deducting all the expenses - They just write off items that are directly related to the rental(insurance, taxes, interest, etc) without factoring in personal expenses that help your rental business.

If you purchase a bunch of cost friendly houses(below $100,000) and are getting close to the 2% rule, then it is likely that you may have positive taxable income from your rentals.

Best of luck

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