You may recall that this is a series of 5 big advantages – or I.D.E.A.L. advantages – of investing in apartment complexes.
“Ideal” stands for:
When it comes to income, that’s pretty easy, although there’s more to it than meets the eye.
However, there’s something else that real estate gives you, and when it comes to apartments, it gives in bulk!
What is this amazing benefit? Tax advantages, of course.
Not only do you get many tax breaks when you own investment property – property that generates rental income – you get a sort of back-handed shadow benefit too.
Do you know what it is?
If you said “phantom cash flow” then you are correct!
We’ll get into phantom cash flow a bit later on.
For now, let’s discuss the big tax break from apartments – depreciation.
The IRS mandates that you depreciate your property. In this case you are like the big boys and taking advantage of the tax loopholes.
You might have thought Uncle Sam wasn’t so nice…
How depreciation really works
When you hear this word, you probably think of the slow crumbling or devaluation of your nice 200 unit apartment complex. Nothing could be further from the truth, in fact!
So what is depreciation?
It’s nothing more than an accounting entry that can save you thousands in tax dollars – or, if you want to look at it another way – make you thousands in phantom income.
Real estate depreciation works in two general ways:
- A tax write-off on the building or buildings.
- A tax write-off on real property attached to, but not necessary to, the structures.
So let’s go back to our example from the “Income” post. (CLICK HERE)
You own a $5.5 million apartment complex with 200 units. Let’s say that the land is worth $500K, and the buildings are worth $5 Million.
Now, the standard depreciation essentially works like this: You divide the value of the buildings by 27.5 which gives you your annual write-off. It’s about 3.5% in other words.
So you depreciate your $5 million building and you get an annual tax write-off of about $175,000. Not bad, right?
If you’re paying at the 30% tax bracket that equals a savings of $52,500 each year in taxes you DON’T have to pay – or that goes into your pocket.
That’s what I mean by phantom cash flow.
Acceleration of Phantom Cash Flow
There’s actually another type of depreciation you can take. Let’s say that of the $5 million building, there’s $1 million in real property that can be written off. Things like doors, windows, appliances, carpet, heating and air conditioning units, lights, etc.
What’s cool about this is that all you do is have your accountant or engage the services of an expert to do a cost segregation.
What happens is that instead of writing off the $1 million over 27.5 years, the useful life can be written off over 5, 7, 15 years depending on the type of real property or asset class.
Let’s assume that the $1 million can be written off in 5 years or at 15% per year.
So, let’s go back and look at our total tax write-offs:
- $4 million in buildings at 3.5% equals about $140,000
- $1 million at 15% equals $150K each year.
So your total write-off for this property is $290k, or a tax write of $87,000 at a 30% tax bracket.
Pretty snazzy huh?
What’ve you got so far…?
Before I wrap this up, I want to review what we’ve covered so far in the in the IDEAL Formula:
“Ideal” stands for:
To refresh yourself about the income, you may want to read about “I” – Income (CLICK HERE)
Next up I’m going to show you how to build equity in your high-value apartment complex – and it has nothing to do with what the market says your property is worth, or how much someone’s opinion is worth.
You can build equity in several different ways, and you can keep building it each year.