Secrets of the Rich
In the past five editions, we have covered the Seven Proven
Steps that the rich use to make and grow their money. In the
first edition, we covered the overview of the system and debuted
the seven steps:
- Create a Business.
- Discover Your Hidden Business Deductions.
- Pay Your Taxes.
- What’s Left Goes Into Real Estate.
- Real Estate Income Comes Out Tax-Free.
- Buy a House the Right Way.
- Make Your House Give You Money.
Last month we discussed the strategy of using your business
income to buy real estate. One more strategy to convert
business income into passive income is to buy the building that
your business is located in. You would hold the property within
an asset-protection entity such as a Limited Liability Company
(LLC) or a Limited Partnership (LP). Your business would then
pay rent to your LLC or LP. This reduces the earned income
within your business. The income flows through to your LLC or
LP and offset by the expenses of the property and the phantom
expense, depreciation. You’re growing wealthier as your
property goes up in value and paying for it all with before-tax
dollars from the business.
Your property goes up in value – now what? If you’ve
determined that leverage is part of your wealth-building
strategy, then you’re going to want to use that equity (equity
is the difference between the asset value and the current loan
balance) to continue to build your wealth. If you haven’t
already done so, go to the Real Estate Wealth Builder at www.taxloopholes.com. You’ll see how leverage
can build your wealth more quickly; by using the equity gain in
your first property to buy more property.
The easiest way to get to the leverage potential within your
property is to refinance and take out the excess equity. This
type of refinancing is typically called a “cash-out refi.” The
proceeds will not be taxable and if you use the money for other
investments, the extra interest is still tax-deductible. If
instead you refinance and take money out to use for personal
expenses, the interest attributable to the personal-use funds
will not be deductible.
Cash Flow Without Tax
If you’ve bought the right property, you will have positive
cash flow each month. The cash flow is the amount that you
receive after all property expenses are paid. That’s the
passive income that you get to put in your pocket. The best
part of all is when you get to put that cash flow in your pocket
WITHOUT paying taxes. That’s where the phantom expense of
depreciation comes in.
Depreciation is a deduction that the IRS allows you to take
based on the premise that your property is going to go down in
value. In fact, they feel that it’s going to be completely
worthless in 27.5 years (residential) or 39 years (commercial).
Subtract the value of the land from the total property basis
(generally the amount you paid for the property) to determine
the total amount that can be depreciated. This depreciation
doesn’t cost you anything, but does reduce the taxable amount
that you have to report and pay taxes on.
Now here’s a loophole – allocate the depreciable value between
real and personal property. Personal property includes the
washer, dryer, refrigerator, store, air conditioning unit and
the like. These items can all be depreciated over a period of
5 – 18 years. That means that you get more depreciation in the
first few years and can generally even create a tax loss even
when there is still cash flow. For more information on how to
allocate land, real and personal property, see Easy
Accounting for Real Estate Investors available at www.taxloopholes.com.
Even further benefits available from real estate are tax
credits. Tax credits directly reduce the amount of tax you pay,
so they are much more beneficial then tax deductions. Just a
few of the tax credits available are: (1) Low Income Housing
Credit (2) Pre-1936 Construction (3) Historical Properties and
(4) ADA. Of these, my favorites are (2) through (4)./ Low
Income Housing Tax Credits are available but are generally
distributed on a political basis. They aren’t as certain. The
pre-1936 construction and historical property tax credits come
about when you rehab a property that is either old (pre-1936) or
historical. Provided you meet certain requirements, you will be
able to take as a tax credit up to 20% of the improvement costs.
The ADA tax credit is earned when you improve a property so that
it is accessible to disabled individuals. You can take up to
$5,000 per year in this tax credit. For more information on tax
credits, see 101 Tax Loopholes, also available at www.taxloopholes.com.
Do you remember playing Monopoly as a child? Do you remember
exchanging four green houses for one red hotel? That was a like-
kind (aka 1031 aka Starker) exchange. The like-kind exchange
allows you to exchange one or more investment properties for one
or more other investment properties. When you do this,
following certain time limit requirements, you are able to
“roll” the basis over from the sold property to a new property.
You have thus deferred the tax on this property into the new
We’ve covered three of the tax-advantaged ways to use your real
estate to build your wealth. In this case, the real estate was
all investment property. There is one more real estate asset-
building technique. That’s to use the great tax advantages
available for your principal residence. Steps Six and Seven
will discuss HomeLoopholes that are available for your principal
residence. Learn how to change your home from a liability to an
asset with these HomeLoopholes..
Diane Kennedy is a CPA/Tax Strategist and the author of the best-selling book Loopholes of the Rich: How the Rich Legally Make More Money and Pay Less Tax and co-author of the best-selling book
Real Estate Loopholes: Secrets of Successful Real Estate Investing. For more information on how to legally use the tax loopholes and make the IRS your partner, contact Diane's CPA firm, DKA, at 888-592-4769 or www.dkacpa.com. Tax law is constantly changing! Keep up to date for free by signing up for a free e-newsletter at www.taxloopholes.com