Chicago Relocation

Cash flow v. tax breaks – Part 1

January 10, 2010

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As mentioned in an earlier post – There are four factors to growing rich with investment property – positive cash flow; tax breaks; capital repayment; and — appreciation.  Each of these can vary significantly year to year and each has a unique effect on the ultimate return on investment property.

Let’s say you buy a lovely goldcoast brownstone apartment on tree-lined Astor St.  You come up with a down-payment (these days upward of 30%+ if you’ll be using it exclusively as a rental).  You then get a mortgage (with a little luck), find a renter and start to collect your rent.

So your mortgage payment of PITI (principal, interest, taxes and insurance) is $3000/month.  And let’s say you rent the place for $5000/month.  With your $2000/month “profit” you earn $22,000/year on your rental property.  Kind of.  That’s assuming you do all the management, advertising, toilet plunging, etc. by yourself and have no outside costs – but that’s another post altogether. But if you have a lucky year (and your tenant always pays you) you make a tidy profit.  In the course of ten years you’ve earned $220,000 and are well on your way to success.  But what about taxes?

Fortunately you have depreciation and other tax benefits that also help you grow  when investing in luxury real estate.  For example you can take advantage of depreciation Our generous government let’s you take a sliding rate of depreciation on the value of the property.  The IRS publishes guidelines each year – You can take a look at publication 946 – “How to Depreciate” .  In some of the early years that you own a property you can deduct up to 3.64% of its value  – which can be used against revenue you earned on property.

For example, if the fair market value is $500,000 for your rental property, you can depreciate it in certain years for 3.64%, or $18,200 (personal property depreciates a bit differently).  That means $18,200 out of the $22,000 you earned in rent is exempt from taxes – leaving you liable for taxes only on the $3800 difference.  You still earned $22,000 but can offset a significant portion of it!  That’s how some properties ”negative cash flow” while still putting money in the owner’s pocket year after year.  I simplify, of course.  That’s why the accountants are the ones who make the REAL money!