How to become a millionaire tax free through real estate

Over the last two centuries, the asset class that has created an overwhelming majority of the world’s millionaires was real estate. Why is this the case, and why is real estate one of the best options to attain wealth while simultaneously being the easiest asset class to avoid paying taxes?

One of the most important things to consider when playing a game is to understand the rules. And in this case, the rules of the game are the IRS tax regulations. As much as the government pervades our daily lives, one of the major sectors that the government has historically left to the private sector is solving the problem of housing it’s citizens.

Because private investment firms and individual investors are encouraged to invest in real estate by the current tax code, there are many rules that the government has created to make real estate a very attractive investment from a tax perspective:

1. Rental income is essentially untaxed in many scenarios (on your personal tax return)
2. You don’t pay taxes on the gain in value on your personal residence (in most cases)
3. 1031 exchange possibilities
   
   

Rental income is essentially untaxed in many scenarios

See the example below of a just above break-even rental property.

• (Cell H5). The property earns about 24k a year
• (Cell H22) After paying for the miscellaneous expenses and buffers related to owning the property, the property earns $2,418 which is what you feel in your bank account.
• (Cell G24) The IRS allows you to depreciate the property over the course of 27.5 years, and based off of the purchase price in this example – the property produces a paper expense of $6,759 per year.

The net effect of this is that while your bank account increases by $2,418 per year (not to mention the price appreciation on the home) you are able to take a $4,341 loss on your tax return decreasing your tax burden from other similar revenue sources. In this case and many others, Real estate only creates a paper loss on your taxes, but real gains for your bank account.

Real estate only creates a paper loss on your taxes, but real gains for your bank account.

Rental income will likely remain in this paper loss position for the 27.5 years that depreciation covers the remaining rental profit. Once the major depreciation expense runs out, there are other methods to roll that over so that you don’t have to show a gain on your tax return.

You -probably- won’t pay taxes on the gain in value on your personal residence

If you have a gain on the sale of your primary residence you don’t have to pay taxes on that gain on up to 250k or 500k for couples filing jointly. In order to qualify for this, taxpayers have to live in the home for 2 out of the last 5 years.

1031 Exchange possibilities

A third major benefit of the IRS tax code regarding real estate is the ability to 1031 exchange your existing property into a different property and defer all the capital gain you would have paid on the transaction. 1031 exchanges require very strict timing and require a qualified intermediary to handle all cash in the transaction. Make sure that you speak to a professional if you are considering this option as it can be tricky to navigate correctly. (read more about the 1031 exchange in our upcoming article)

Essentially, capital gains from real estate can be rolled over repeatedly and traded into like-kind properties such as land, another home, or commercial property investments etc.. Since you can roll the capital gain until property Is distributed in estate, many taxpayers can essentially never pay taxes on the gain on their real estate investment if their goal is to pass the investments on to their kids.

Conclusion

The US tax code is essentially designed to make real estate ownership/investment a very tax efficient method of building wealth. If done correctly, investors can build millions of dollars of value without paying the ordinary tax rates that would sting most W2 earners. Obviously, investors should do their own research and make sure the numbers make sense on their particular real estate deal.

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If you invested in a rental property, want to do a 1031 exchange or just for more information – get booked for a call with your Booked Financial Rep

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This tax information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Booked Financial LLC recommends that you consult with a qualified tax advisor, CPA, financial planner, or investment manager. Depending on the nature of your business there are different variables that would make one option better than the other.  Please understand these before choosing to deduct expenses under actual or standard mileage on your tax returns.

The content of this post is provided as educational information only and is not intended to provide investment or other advice. This material is not to be construed as a recommendation or solicitation to buy or sell any security, financial product, instrument, or to participate in any particular trading strategy.

This blog post was prepared by Dustin Wong in my own personal capacity. The opinions expressed in this video are my own and do not reflect the view of Booked Financial LLC.