What’s the rate of return on savings accounts these days? How about in the stock market? CDs? Bonds? This stuff changes every day, but one thing I know for sure: none of them are anywhere near 100%. Heck, they’re not even in the double digits.
How Tax Law Can Help You Make Even More Money in Real Estate
Just based on my cash flow formulas alone, real estate can consistently bring you a 20 to 30% return on your cash investment. In fact, I advise you to walk away from any deal that would net you less. Just try getting that kind of interest rate on a savings account.
A 30% return is pretty amazing on its own. But guess what – your net return on investment will probably be even higher. As I’ve said before, smart real estate investments can consistently bring you a 70, 80, even 100% return.
How is that possible? Believe it or not, it’s all thanks to Uncle Sam and the U.S. tax code. Just by filing your taxes, you can save thousands – and double or even triple your rate of return.
In real estate, we talk a lot about appreciation. But when real estate investors (or our accountants) talk taxes, they talk depreciation – the amount that the asset loses in value each year.
Uncle Sam says that land doesn’t depreciate – but the structure on the land does. Luckily, the value of the land is typically only about 10% of the total value – check the tax bill for the property to be sure. But for our purposes, let’s say we’ve got a $100,000 property: the land is valued at $10,000 and the structure at $90,000.
Uncle Sam has also decided that structures last 27.5 years. (Don’t ask me where they get this number – I think they pick it out of a hat and they seem to change it every few years.) So to figure your structure’s rate of depreciation, you take the structure value listed on your tax assessment and divide it by 27.5. In our example, that comes out to $3,272 and change.
Now here’s the good part: the law says you can deduct that annual depreciation amount directly from your gross annual income. That means that if you make $50,000 a year before taxes in salary, you only have to pay taxes on $46,728. If you’re in the 28% tax bracket, that will save you a little more than $900.
When you figure that tax savings into your rate of return for the property, you can see how easily your rate of return can jump from 20 or 30% to 70, 80, even 100%. And remember that if you have multiple properties – and you should – you can deduct depreciation for each one.
If thinking about the IRS makes your stomach churn, don’t worry – you don’t have to be an expert in tax law to take advantage of these savings. When I got started, I didn’t even know the tax advantages existed – and I didn’t care. I made my investing decisions based solely on the cash flow return, sticking to the 20 to 30% rule, and my accountant figured it all out for me at the end of the year.
That’s just what you should do too – focus on the cash on cash return and leave the rest to the experts. If you get that right, you get all the rest whether you know how to figure it out or not. Think of it as a bonus from Uncle Sam – and yet another way that real estate can put money in your pocket.