Would you still buy the deal without the tax break?

Question

Here’s a question I like to ask investors:

If the tax deduction disappeared tomorrow, would the deal still make sense?

I see investors get excited about depreciation, cost segregation, and other tax benefits.

Those can be valuable.

But I always say: the tax benefit should support a good investment, not make a bad investment look good.

So let’s hear it:

Have you ever passed on a deal because the numbers didn’t work, even though the tax benefits looked great?

Fulton Abraham Sanchez · Answer

@Igor Ganapolsky, hi. Exactly. Tax strategy should improve a strong investment, not rescue a weak one.

From the CPA side, the biggest value usually comes after acquisition, how you structure the hold, track basis and improvements, use depreciation, and plan the exit. That’s where good tax planning can materially affect the investor’s net return without distorting the original deal analysis.

Kasing Ng · Answer

Good question, and I would go one step further. The tax benefit almost never turns a bad deal into a good one. It changes the timing of the return, not the size of it. Depreciation and cost seg pull deductions forward, but a lot of that comes back as recapture when you sell, and the personal property piece gets taxed at ordinary rates, not capital gains. So a deal that only works because of year one bonus is really borrowing return from its own exit.

I come at this from the modeling side. The cleanest way is to underwrite the deal on its pre tax numbers first, going in yield, debt coverage, cash on cash, and only then look at what tax does on top. If the deal only clears the hurdle once you add depreciation, the tax line is carrying it, and that is where I get cautious. Two reasons. First, the investor has to actually use the losses that year, and a lot of LPs cannot, so they suspend until there is passive income or a sale. Second, the exit, where recapture hands part of that early deduction back at ordinary rates. Real benefit, just smaller and later than the year one number suggests.

So to your question, the deals worth passing on are the ones where the tax line is doing the heavy lifting. Take it out and see if the going in yield still covers debt service in a soft year. If it does not, the depreciation was real and the deal still was not.

Igor Ganapolsky · Answer

@Fulton Abraham Sanchez agreed, and that's the part most people skip past. The deal math happens at the auction, but the money you keep or lose after that is all structuring.

The wrinkle on the tax deed side is basis. Your basis is the winning bid plus costs, not what the property is worth. So I can take down a parcel the BCPA has at $579K for a $60K bid, and my depreciation schedule is built on $60K. That gap between basis and value is the entire reason to buy this way, and it's also the thing that catches people off guard at tax time when the write-off is nowhere near what they expected.

One I'd like your read on: quiet title legal fees after a tax deed purchase. Capitalize them into basis, or expense them in the year incurred? I've seen it argued both ways.

Igor Ganapolsky · Answer

Hi William, interesting question. I buy properties at county tax deed auctions in Florida, so tax benefits like depreciation aren't really a factor in my analysis. At the auction, I'm buying well below market value with cash — the deal either works based on purchase price vs. after-repair value and rehab costs, or it doesn't. The IRS isn't part of that math.

That said, for conventional rental deals, I agree with what a few others have said — tax benefits should support a good deal, never make a bad deal look good. If the only reason a property pencils out is because of depreciation or a 1031 exchange, that's a red flag. The cash flow needs to work on its own merits. Taxes are a bonus, not the foundation.

Where I've seen tax breaks actually matter is in the exit strategy. When I'm deciding whether to hold a tax deed property as a rental or flip it after rehab, the capital gains treatment can tip the scales. But that's a decision I'm making after I already own the property and know the numbers — not something that drives the initial purchase decision.

For most investors I think the healthy approach is: underwrite the deal assuming you'll pay full taxes on every dollar. If it still cash flows, great. Then your CPA can help you legally minimize what you owe. But buying a property because of tax advantages without solid fundamentals underneath is how people end up with negative cash flow and a confusing tax return.

Marc Winter · Answer

Tax advantages in real estate are mainly good only for reducing your earned income, ie W-2. You can get deductions in other ventures that lose money; but real estate creates a phantom loss via depreciation, while over time it actually appreciates.

Remember when you sell, the depreciation is recaptured.

In short, if you are only buying because of the tax advantage and the deal otherwise is only so-so, I'd pass.

Michael K Gallagher · Answer

I get the point and generally agree with it but that's also similar to what people think when they say things like "only buy it if it works as along term" even if you plan to do something else with it. If the intent of the deal itself is the tax advantage, isn't the exercise of removing that benefit and evaluating "devaluing" the deal from the initial goal of the investment anyway? So of course it wouldn't work is what I'm thinking.

Would you still buy the deal without the tax break?

Would you still buy the deal without the tax break?

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