Why It’s Almost Always a Bad Idea to Invest in Real Estate to Save Money on Taxes

by | BiggerPockets.com

I’m going to talk to you today about something that I’ve been wondering: Why would you invest in real estate to save money on taxes?

This might be the most ridiculous thing I have ever heard in my life, and it is something that is very, very frustrating to me. I just don’t get the principles behind it, and the fundamentals of it don’t make any sense.

Download Your FREE copy of ‘How to Rent Your House!’

Renting your house is a great way to enter the world of real estate investing, but most first-timers (understandably) have a lot of questions. Fortunately, the experts at BiggerPockets have put together a complimentary guide on ‘How to Rent Your House’. All the skills, tools, and confidence you need to successfully rent your house are just a mouse-click away.

Click Here For Your Free Guide to Renting Your House

Why It’s Almost Always a Bad Idea to Invest in Real Estate to Save Money on Taxes

So, let me start off with my Aussie investors. A ton of you out there are using this thing called “negative gearing.” This means you’re investing in these super-duper expensive properties that cost you more than the income that you are getting every month. You are losing that money, but then you are losing all those losses to offset the income you are making from a 9-5. Guys, that is not why we invest in real estate. We invest in real estate to make money and to pay our taxes fairly. I always say I wish that I was paying $10 million in taxes, and do you know why? Because that would mean I’d probably be making $100 million. In the U.S. (and I know in Australia, too) the taxation system favors businesses. The more money you make as a business owner, the fewer taxes you pay. Unfortunately, that’s just the way it is.

Now, for everyone here on the East coast and West coast of the United States, your markets have boomed. They’ve gone up in value. So a lot of you guys can’t take advantage of losing money every single month by offsetting it against your income. Still, it is mind boggling to me that you are investing in these properties, losing money on your monthly mortgage repayments, which means your income is not covering your expenses. But you are doing that because of some prediction and hope that the property is going to appreciate in value more than you are losing on your mortgage repayments.

Related: Cash Flow vs. Appreciation: What Experienced Investors Know About the Debate That You Don’t

Use Real Estate Investing to Supplement Your Income

Once again, this is mind boggling to me. I don’t get it. It doesn’t make any sense. Real estate should be about putting money in your pocket every single month. Forget about capital appreciation. I mentioned it in one of my previous blog posts that capital appreciation is a prediction. It is speculating because we don’t know what the future holds. You guys have to invest based on the numbers in the deal as they stand today. This means your income has to outweigh your expenses. There has to be positive cashflow left over, and there has to be a ton of money pouring into your pocket every single month.

Remember, we invest in real estate to supplement the income we are getting from a job we do not want to be working in. So why are you investing in capital appreciation? That will not supplement your income. That is intangible. It is equity; today it’s there, and tomorrow it could be gone. We don’t know where the market is going. We can’t predict the future.

So, again, do not do it. Invest based on cash flow; invest based on making an absolute fortune. When you make more money, pay your taxes fair and square. I said that the tax system favors business owners and folks doing well, so I’m sure you’ll have other tax advantages you can use through a good accountant.

Investors: What do you think of this assessment?

Leave your thoughts below!

About Author

Engelo Rumora

Engelo Rumora “The Real Estate Dingo" is a successful property investor, motivational speaker and serial entrepreneur that quit school at the age of 14 and played professional soccer at 18. He is also a soon to be published author along with becoming a TV personality in his very own real estate house flipping show. To find out more go to engelorumora.com . Engelo Rumora has been involved in over 400 real estate deals and founded five businesses in Ohio. The most successful is Ohio Cashflow, a company that specializes in providing turnkey properties in several Ohio markets. The newest venture is List’n Sell Realty, a real estate brokerage based in Toledo, Ohio and soon to be known as the #1 discount broker in the country.

25 Comments

  1. Darren Sager

    I’ve never understood this concept and why people do it. Completely foolish in my opinion, although I’d have to say I wouldn’t mind having some of these people doing this as clients because it would put money in my pocket helping them “save on taxes…..”

  2. Brandon Hall

    I think this is a stretch. You’re making an argument to buy rentals that cash flow and trying to use taxes as the scapegoat.

    Fact of the matter is that all real estate income, positive or negative, is tax advantageous. You can net $10,000, pay taxes as if you only earned $2,000 and end up with a <10% effective tax rate.

    Shoot even in your example where you are paying $10MM in taxes on $100MM in income is a great example of what real estate can do in terms of saving on taxes.

    The point you failed to make is that it's not about reducing your tax liability, it's about reducing your effective tax rate. That wasn't touched on at all.

    And I'd be careful with the "one size fits all" approach. If you have a cash flowing portfolio that produces passive taxable income, a legitimate strategy could be to pick up a property in a highly appreciating area that breaks even or even has negative cash flow. But between the principal paydown and the passive taxable losses that offset your other passive income, you have a highly effective asset.

    Just think this article wasn't well thought out and clearly promotes cash flowing property, of which the author sells…

    • Engelo Rumora

      Thanks Brandon,

      I stretch every day after gym 🙂

      This is so wrong that I won’t even bother having an exchange with you here – “pick up a property in a highly appreciating area that breaks even or even has negative cash flow.”

      Folks can just go out and “pick up” a crystal ball first so they can figure out what area will appreciate… lol

      Plus, you obviously don’t know me at all but I have 3,000+ comments on BP and never pitch my product or company.

      I turn down more business than I take on and always call it as it is.

      Much success with your CPA endeavors

  3. Brandon Hall

    I know you don’t promote your business and I really enjoy your articles. I just think this article is biased.

    Consider an investor with a net worth of $10MM, a portfolio cash flowing $100k annually and a need to place capital in a tax sheltered manner. If they want to increase their real estate exposure, a San Fransico (land locked) or DC (height limits imposed) property can be a really solid play. It is *almost guaranteed* to appreciate, and the passive losses will help reduce overall taxable income. Best case is that they get close to breaking even from a cash flow perspective. The principal paydown is so huge that it’s not “cash flow” but is definitely equity build and the annual appreciation as population density increases can’t be ignored. Not to mention the tax savings from the taxable passive losses.

    In that case, it could make for a perfect move.

    Of course the above example is extrapolated to prove a point – a $10MM net worth is obviously difficult to achieve.

    Or if that’s too much of a stretch, look at historic tax credit rehabs.

    Point is there are plenty of legitimate reasons to invest with a focus on tax savings. That’s the overall goal – to have income that is tax advantageous through business and real estate.

    All of this I know you know, just not clear in this article 🙂

    Anyway, sorry for butting in. Keep writing great content!

    • Engelo Rumora

      Thanks mate,

      You’re the tax expert and as we say in Australia “There are many ways to skin a cat” lol

      I’m still for investing every penny I have in cashflow and making more of it.

      I guess, I “save” on paying taxes with my off shore investments.

      Not sure if that even classifies as a saving on tax but there is no income tax in a few countries that I buy RE in.

      Feel free to butt in anytime.

      I always counter in an “A$$hole” way just to stir the pot so I start a banter and more folks see my blog hehe

      Thanks again and have a great day

    • Hans Thurau

      Hello Brandon, I am not in complete agreement with you stating that property in San Francisco or DC is **almost guaranteed** to appreciate. California has been an exception to the rule if you can perfectly time catching the falling knife. The appreciation experienced in the larger metros of California (for example) since the recession has been truly amazing; but I feel the momentum is slowing down. I own beach property in California and at the height of the market it was appraised at $2.6 million. After the recession hit and prices bottomed out, it dropped to $1.2M and is now worth about $1.6M. Close to $1M of the appreciated value never came back; all these investors who purchased beach properties at the height of the market lost their shirts. Back in the first housing bubble of the early mid 2000s, I remember thinking these values are just going to keep going up, but they didn’t. Buying for appreciation comes down to timing, but also on the flip side being able to exit advantageously and not lose your a$$ is even more important. There are other ways to structure your business entity so that you don’t need to take these high risks. I’m with the Dingo on this one, I’d rather be safe than sorry. BTW my beach property appreciated 450% since purchasing it in the 90s and has cash flowed the whole time.

  4. Jack Eyer

    Brandon you make very good points and Engelo it may not be the reason to buy RE, especially HIGH END RE as you state- risk greater but I do consider Tax Favor ability as one of the Three Legs on the Stool of benefits to buy RE. Being WAY DOWN the road investing in Real Estate 35+ YEARS it has been a great tax hedge and reducer many years for myself on earned income. It can be at times like a “Matching 401k with IRS on repairs & many other items found on schedule C to offset earned income, plus the kicker of depreciation.

    Now if you Don’t have Earned Income, not so good against passive rental income!! That should be your main point. Run a business or E. Income outside Real Estate- oh YEA it can bring a might good tax deferral benefit. Defer, Defer, Defer some more my friend… I LOVE REAL ESTATE and this is just one leg on the STOOL to own it. There might even be 4 or 5 legs on the stool, not just three.

    I refer to it why the unknowing public don’t get the Donald J. Trump income tax question- show me the return? A better question for me is HOW MUCH Property Tax do you pay, and Payroll Tax Donald- step up on these Trump should say to Democrats. Can you imagine Trumps answer on these two??- I CAN….

  5. Alex Deters

    I agree with the author that why should you invest in a venture you know will be losing money and that this is completely speculative, and is no better than investing in undeveloped land. The land or cash losing real estate investment might eventually increase in value and you could make a lot of money. But you can’t tell the future and you may need to sell before ever getting your profit back that you lost by not investing in profitable and cash flowing property. My experience is mostly from being a business and bank auditor and cpa. I have seen loans for people that they have been paying on forever with hopes of land appreciating enough for them to sell before they die. And there have been countless real estate crashes and corrections just as in any market, and being leveraged increases your risk in a situation like this.

  6. Llewelyn A.

    Engelo,

    I have to say you are very entertaining!

    I want to point out that just because you are making a cashflow in your current property doesn’t mean you will always have the same cashflow. Just ask a large percentage of those who owned said cashflowing properties and went through the last financial crisis. We are talking about MILLIONS of properties that suddenly started to be negative when it was a positive cashflow previously.

    I have been investing for 2 decades in only appreciating markets, specifically, Brooklyn, NY.

    What you are not tying together is that High Appreciation does not mean that your cashflow stays the same throughout history forever. I just don’t get that concept.

    Sophisticated Investors look for future growth in both Cashflow and Appreciation. The two go hand in hand.

    For instance, I bought a property in the year 2000 that had 2 apts which rented for around $500 per month.

    Today, they rent for $2,000 per month.

    Because of the rental appreciation, the value of the property went from $140k in the year 2000 to $1 Million today.

    I think you are mixing up the Causation.

    Properties appreciate not because the value goes higher for no reason at all.

    Properties appreciate because of several reasons, including that the Net Operating Income appreciates or that you get a higher return than previous Interest Rates for competitive low risk instruments.

    While you don’t want to be convinced that it’s ok to buy in Appreciating Markets, at least consider that Current Cashflow never really stays the same. The Wise Investor needs to predict the Quality and Quantity of that Cashflow for the future. Then they make their decision.

    This is by far the number one reason why I buy in High Appreciating area. It’s not because the Property Appreciates, that just a Symptom of the real reason. It’s because of Appreciating Net Operating Income.

    It’s also the same in the Stock Market. The High the expectation of increasing Net Operating Income, Free Cashflow, or other metrics, the much higher the current valuation as the Investor seeks to capture the value of the Future Growth.

    In other words, buy it now because the obvious income growth will lead to much more cashflow and higher Valuation. So if Apple is selling with an expectation of say a 5% future growth of their free Cashflow, it is cheap when that future growth turns out to be 10% or better for the next 5 to 10 years.

    Same with Real Estate.

    Sorry for the long winded explanation.

    • Engelo Rumora

      Thanks for your comment Llewelyn,

      I do my best to make all of my videos different and entertaining.

      I think your comment is wrong and that you are fortunate for stumbling across a great market like NY 20 years ago.

      I also don’t agree with you here at all

      “I want to point out that just because you are making a cashflow in your current property doesn’t mean you will always have the same cashflow. Just ask a large percentage of those who owned said cashflowing properties and went through the last financial crisis. We are talking about MILLIONS of properties that suddenly started to be negative when it was a positive cashflow previously.”

      Those millions of folks that “owned” cashflowing properties like you mention where most likely the same folks that like yourself bought using a tonne of leverage and based their decision on specalution that the property will appreciate.

      Many where wrong and now sophisticated investors like myself are buying all of the foreclosed homes and making huge amounts of cashflow not even bothering to worry about any growth.

      The numbers TODAY don’t lie.

      All other future estimates are a gamble.

      Thanks again and much success

      • Llewelyn A.

        You can certainly consider that future calculations are a gamble. But again, predicting that you will have a stable future cashflow is also the same kind of gamble.

        I’d also like to share what happened to a close friend of mine who bought Cashflowing Properties outside of NYC.

        In 2004, Steve bought several properties with around $200k Invested in CT. He was cashflowing around $1k per month.

        During the same time, I bought a 4 Family in Brooklyn for around the same Invested Capital.

        Steve also lived in NYC.

        Fast forward to today. Steve, even though he was making $1k per month for the last 13 years, his rents doubled causing him to have to pay much more than the $1k per month he continues to generate. His Appreciation is non-existent.

        Steve moved to a lower cost of living city in NJ.

        Comparing it to the Investment I made during the same time, my Cashflow is over $4k per month after starting out at break even. I’ve generated more cashflow than Steve made over the 13 years.

        When it comes to appreciation, I’ve made a $1 million dollars more.

        Why the huge difference? It’s the understanding of Luck.

        To get lucky, you will need two things: 1) You must recognize the opportunity and 2) You must be prepared to buy the opportunity. Without these two, you cannot get lucky.

        So Steve did well, as according to the Cash Flow Investors. He made a consistent 12% Cash on Cash return.

        However, he lost the ability to stay in his residence because he refused to have bought the same apt he lived in. Had he not bought his cash flowing properties and just bought the apt he lived in, he would have been about a $1 Million richer.

        Now Steve is out priced and had to move to a less expensive location. I’ve seen this many times.

        I’m not denying luck played a part that contributed to my wealth. But if you cannot recognize the Opportunity, you cannot achieve the same kind of luck.

        Also, I’m fine with Investors thinking differently that I. It eliminates my competition and give me that competitive advantage.

        • Engelo Rumora

          Thanks for your detailed reply,

          Few things you mentioned that are wrong in my opinion.

          Cashflow estimates are based on the numbers today and not the future like appreciation is speculated on.

          Another thing is “luck”.

          I don’t believe in it and I think investors should make their own “luck” by hustling every day and not waiting for the market to rise.

          Thanks again and much success

          ps. Steve didn’t do well buying only a few properties. Steve would have done well if he bought 20+ properties without using leverage

        • Llewelyn A.

          No Worries Engelo.

          There is a difference between someone like me who has 20 years of Real Estate Experience starting from 1997, where I went through at least 3 down turns.
          1) The Financial Crash of the Nasdaq in 2001 where Nasdaq lost 66% of it’s value.
          2) That was followed by the biggest terrorist event on 9/11 and
          3) the biggest recession that has ever hit our generation in 2007 to 2008.

          The problem I am having is that you are so confident in your theories and yet you started investing in 2011, from what I have read.

          But I do wish you all the luck when you really go through an economic downturn.

          I’m not saying you will lose money, but you are so confident that you won’t that you may not actually see it until it hits.

          Wishing you all the best.

  7. John Murray

    The tax advantages of any passive income are great. Real estate offers great tax benefits especially BRRR. The leverage of the total sum is greater than the initial investment. Rent profit is offset by depreciation and other write offs. Refinance is tax free (like Yogi would say that is just like free money). Yogi was a baseball player and quite pragmatic. For example in 2016 I made just north $250K and my CPA told me my taxable income was about $30K. What percentage did I pay on that amount? I was below the poverty line. Take a guess. Try to do that as a W-2 earner and you maybe talking to a federal prison guard in the future.

    • Engelo Rumora

      Thanks John and agreed.

      Great comment mate

      God bless America as the more money you make, the “less” tax you pay lol

      I’m all for making a tonne of profit and cashflow.

      Just bloody pay your taxes fairly also

      It should be like a scorecard.

      I’m proud of my tax bill getting higher every year 🙂

      Much success

  8. Susan Maneck

    It makes sense to me if you are talking about property which is truly losing money, but for those properties which have a positive cash flow, real estate provides an incredible tax shelter. I’m with John Murray here, though I didn’t do quite as well. My gross income was about 100K whereas my taxable income turned out to be less than 30K. For reasons that make absolutely no sense to me at all, passive income in the US is taxed at a much lower rate than earned income. My rental income enables me to max out my retirement funds bringing down my tax bracket to about 13%.

  9. Engelo Rumora

    Thanks again Llewelyn,

    I have always been confident in everything I do and stress my strategies passionately.

    I’m not arguing that I’m right or wrong.

    Just stressing my beliefs.

    As for my “short” experience.

    Currently, i’m running 4 companies, 14 full time staff and supporting 50+ more that are out of office.

    I’ve also done over 400+ deals in 5 years and have surrounded myself with some of the brightest minds in business and in real estate.

    I unofficially retired 6 months ago and can comfortable go to the Bahamas and sip Pina Coladas whenever I choose without the worry of a downturn (As long as there doesn’t become a shortage of Rum lol).

    So, I wish you continued “luck” with your strategy for the next 20+ years

    Have a great day

    • Llewelyn A.

      Hi Engelo. No worries at all really. I’m not really concerned about you or I.

      I’m MUCH more concerned about the readers of these posts where you would shoot down a strategy in place of what worked for you in an economy that Roared from 2011 to now.

      Unfortunately, the vast majority of people will not be like an Engelo or me. They won’t be able to set themselves up to weather the storms that will eventually come.

      My strategy, which you call Risky, weathered multiple very high intense storms. In fact, the Financial Crisis was the worst Storm you could have went through. There wasn’t much damage that was Done because NYC has so many other Industries that a bomb in the Financial Industry was picked up by Tourism, International Real Estate, Fashion, etc.

      You care about your Audience. I care about your Audience. Don’t shoot down a strategy so quickly and Authoritatively as if there is only one possible strategy, yours. Keep in mind that Manhattan (below 96th Street) only had 14 foreclosures in one of the worst years during the financial crisis. That’s powerful protection and mainly because NYC’s majority of apts are Coops, not Condos. That difference puts a shield which protects your investments because a Coop board makes sure you don’t do ANYTHING risky like NOT live in your apt but flip it constantly. You can’t get the kind of thing that happened in the financial crisis here as you did in Miami.

      You may weather the upcoming storm because of your energy and strength in what you have done. But the vast amount of people will not be able to dig their foundation solidly enough to weather the next inevitable storm that must come as every Business Cycle has it’s up and it’s down.

      I’m not trying to advocate my strategy over yours. I’m trying to get you to open up that your strategy can become dangerous in the wrong time without adequate resources for someone else.

      In other words, someone else following your strategy may become as successful as you but the vast majority won’t. Those others may be building a house of cards just before the storm.

      The only problem I’m finding with your personality is the adherence to making everyone like you which is great. But if you don’t recognize that your audience may only achieve just a little bit of your strategy…..

      Anyway, I’m hoping there will be enough people to understand they should be very careful as the business cycle has not fallen in about 9 years. We are vastly overdue.

      • Engelo Rumora

        Thanks Llewelyn,

        It’s quite simple in my eyes.

        The investors that loose money in a downturn are the ones least educated and knowledgeable on what they are doing.

        They also make mistakes by trusting the wrong people.

        Having quit school at 14, not being able to read or type properly and having poor grammar skills like I do I can comfortable tell you that nothing beats hard work.

        I can also 100% guarantee that if my audience just put in 50% of the blood, sweat and tears that I do everyday and no matter what strategy they use, they wouldn’t or couldn’t fail in the long run.

        I’ll leave it at that

        I respect the exchange we had and am looking forward to catching up with you on the next blog.

        Have a great day

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here