We are approaching the end of another year. While it is not yet time to prepare tax returns it is a great time to consider ways to maximize your tax benefits and minimize taxes. One way to do this is to consider the timing of potential expenses.
This will be short and sweet for a couple reasons. First, tonight’s post is over at BiggerPockets Blog. If you’re not acquainted with it I give my full and energetic endorsement to it. I’ve been writing there for a couple years, or at least in a few weeks. It’s the best membership site for real estate investors in the country.
BawldGuy Heads Up: Tomorrow (Wednesday) I’ll be out of touch with the world completely. Gettin’ some dental work done, and they wanna knock me out to do it. Works for me.
I’ll be available for calls beginning at noon Thursday. ‘Course by then I’ll be Jonesin’ for a fix. You can help me with that by callin’ me at 619 889-7100. Or you can, if you prefer, send me a note using the Contact BawldGuy button up top. Have a good one.
There are two basic approaches to real estate investing. Investing for current income or investing for future income. Both approaches are useful depending on where you want to go and where you are in your plan. This is where you might hear the BawldGuy talking about Purposeful Planning.
There are a number of ways real estate can create current income. The best examples would be through wholesaling and flipping. In this post, I want to look at rental property which can be selected to emphasize income or capital growth.
Rental property has four ways to create wealth or income.
• Cash flow
• Equity buildup
• Tax savings
Sometimes we’re so close to something day to day that a question can get us doin’ the RCA Dog impression without warning. One such question is probably one asked of me the other day — which I thought might be on more than just her mind. She asked,
“When you say the ‘after tax’ cash flow is $X, what gets taxed, and is it like my paycheck’s ‘after tax’ sadness?”
Well, sometimes it’s the same. For many however, the after tax cash flow is actually greater than the before tax cash flow.
How can this happen?
I think most real estate investors understand how depreciation creates a significant tax advantage. Depreciation is the means that allows an investor to have a positive cash flow while claiming tax losses. I think we can all agree that spending a lot of cash to create tax losses is a less than desirable way of saving money on your tax return.
I suspect though that many investors have no idea just how much depreciation can be taken in the early years of a property’s life. Spreading depreciation out over 27.5 years does help the bottom line, but if it was possible to spread a lot of that depreciation over a 5 year period I think you can see how that might prove to be a far better tax benefit.
This topic I have to address, as lately I’ve had several similar comments that basically reflect to the title of this blog. Many people erroneously believe that when they choose to self-direct, they have to self-direct their funds into the same type of account from the type of account that it is coming from. Since I’ve never been a great writer, let’s put it more bluntly:
Many people believe if their funds are in an old 401K, then they have to roll it over into a new 401K, and if their funds came from an IRA, then have to move their funds to a new IRA.
Is any part of the previous statement true? Well, yes, but not for the reason many think. It is true that Roth IRA funds cannot be transferred into a 401K plan unless it is a designated Roth 401K. Otherwise, however, there is no truth in the statement.
One important lesson that every investor learns sooner or later is that land is not a depreciable asset. You may hear it from your tax preparer, a real estate broker, another investor or others. I’m hoping that no one found this out in an audit.
What many might not be aware of though, is that land improvements are deductible. There are many improvements that we make to land. Some of which you might not think of generally as improvements.
As a CPA specializing in real estate transactions, I have seen many ill prepared returns. Much of the time it is because the tax return preparers are not familiar with the subtleties of the tax law or completely unaware of how to handle certain transactions. Many may rely on software thinking it can be a fail safe way of getting the return done right, when in fact many things can be missed simply because the preparer doesn’t know to check for something.
Common situations mishandled by tax preparers and software:
Depreciation is one of the greatest advantages of investing in real estate. Depreciation allows for a property to have some positive cash flow, and yet for tax purposes still allow for a paper loss. This is what is commonly called a tax shelter. While many tax shelters have been made illegal or have been done away with, the ability to use real estate as a tax shelter remains a common and legal shelter.
I’ll not going to take the time to describe what depreciation is here but the BawldGuy does a great job of describing it here in various posts.
I receive many a calls regarding both self-directed IRAs and 401Ks as to how they are established and how one qualifies for either. Typically, and not surprisingly, many individuals are not aware of both the subtle and unsubtle differences between the two. As I have written many posts about the differences between the two (and they are considerable), this post addresses IRAs (whether self-directed or not) and the role of the IRA custodian. PGI Agency, Inc. is not an IRA custodian, but rather a facilitator for the self-directed IRAs.
You MUST have a custodian.
Simply stated, whether we like it or not, the IRS requires that anyone who has an IRA must have an IRA Custodian for their plan. This was mandated by Congress when IRAs first came to be and the rules have not changed. The IRA Custodian is a bank, trust, financial services company, insurance company or any other company that has received written authorization to serve as an IRA Custodian by the IRS.