UNDERSTANDING THE TAX BENEFITS OF PASSIVE INVESTING
Disclaimer: We are not tax professionals. Do not construe this blog as tax or legal advice. You should speak to your tax and legal professionals about your unique situation before making any decisions that could affect your financial future.
Cash flow is amazing, but things get even better when we factor in the tax benefits. A couple quick takes on taxes.
First, the government doesn’t want you overpaying. The purpose of the tax code is to outline all the ways to reduce your taxable liability. Seeking to legally reduce how much you pay in taxes isn’t shady or illegal, it’s smart, and it’s exactly what all the wealthiest people (including our legislative representatives) utilize to keep more of what they earned. Learn to use taxes to your advantage.
Second, the government offers tremendous perks to real estate investors because it’s an important service they want to incentivize. And this makes sense. The government wants a strong economy and stable homes for its citizens. The government doesn’t want to take responsibility for housing people (which is a good thing, given the inefficiency of most government agencies), so they encourage investors to participate in this asset class by offering tax breaks, the most notable of which comes through the magic of depreciation.
Depreciation recognizes that buildings wear down over time and theoretically lose value. The government allows investors to write off this theoretical loss in value. Now, I say “theoretical” because, in reality, despite buildings wearing out, real estate tends to appreciate in value over time. Why? Because it’s a finite resource (fixed supply) being competed over by an expanding population coupled with inflation (demand). All this leads to the double benefit of owning an asset that simultaneously appreciates and depreciates. Pretty crazy, huh?
Unlike other investment vehicles, like stocks (which not only offer zero tax breaks, but are also taxed at unfavorable rates), this depreciation means you’re unlikely to pay taxes on yearly cash flow over the life of a project. That means more money in your pocket now. The time value of money and opportunity cost are powerful drivers of wealth when correctly utilized.
Time Value of Money
Here’s a basic rule of investing: A dollar today is worth more than a dollar in the future, due to its potential earning capacity. If we have money sitting in a savings account, for instance, it’s earning an interest rate and compounding. Effectively, money in hand today can be put to work so that it’s also earning.
When we make a decision between two potential paths through life, we have to take into consideration the often-unseen effect of opportunity cost. What are those potential benefits we’re foregoing by choosing one path over another? Opportunity costs are often invisible and easily overlooked. That’s a mistake. The best decisions come after careful consideration of all the foreseeable opportunity costs. Failure to consider the opportunity costs results in a decision based on incomplete information.
The Perfect Investment Vehicle?
Apartments aren’t the perfect investment vehicle because there is no such thing. Every investment is inherently risky. With that said, throughout all of our years of searching, we’ve yet to find any other investment vehicle that offers the same combination of stability, high risk-adjusted returns, control, cash flow, and tax benefits.
Most people, once they become aware of this investment vehicle, are eager to get involved, but they’re faced with a couple potentially big hurdles to overcome. First, money. Apartment buildings are expensive. There’s no getting around that. Most people don’t have enough money lying around to go out and buy a ten-million-dollar building. Second, they lack the knowledge necessary to buy, operate, and sell a property. The majority of people throw their hands up in despair and give up at this point.
But not you. You’re committed to finding a way to overcome these obstacles. Well, seek and ye shall find. The answer is to partner with other investors in an apartment syndication and enjoy all the tax benefits of passive investing.Posted by DRG *Mpls on