I have always been interested in passive income. Through our years of experience in real estate and creating passive income streams, we have realized one thing to be true. How much you make in a single year is not very significant. Let me repeat that again, it does not matter how much you make in a year! All that really matters is how much you keep. Real estate is one of the best ways to defer taxes in the United States. I will be breaking down the top three ways to create passive income that is taxed at a very low rate. I want to warn you before I go into the strategies that have worked for us that I am not a licensed CPA, nor do I care to be. I would advise speaking with yours before taking any of my advice. You can schedule a call with our real estate CPA here, as they are familiar and have executed every strategy I am about to share.
Real Estate Professional Status (REPS)
I may be somewhat biased here since my business revolves around using REPS to our benefit.
To qualify for REPS, you must perform more than 50% of your working hours in a real estate-oriented field and spend more than 750 hours working per year. Typically, people with full-time W-2 income will not qualify.
Why is qualifying important?
Once you qualify, you are able to offset active income with passive losses from a multifamily syndication or real estate deal you are actively involved in. Let me draw this out in an example.
Many people have asked us how they can obtain passive losses on paper without losing any real money. This is through depreciation. For multifamily properties, which Preston and I specialize in, these assets are depreciated over 27.5 years.
That helps our tax burden because we can write-off what the property is worth over the 27.5-year period.
For example,
Let’s say a property is worth $1,000,000, we can depreciate it over 27.5 years.
$1,000,000/27.5 years= $36,363 per year you can write off.
Well Capital uses what is called a cost segregation study to dissect each aspect of a multifamily property in order to accelerate that depreciation. This means we are able to take that depreciation within the first few years of ownership. This could be $500,000 in depreciation based on the example above.
The absolute best part for you, is that we pass this accelerated depreciation through to you, the investor. You are then able to, as a Real Estate Professional, offset your active income with this passive loss, AKA depreciation.
The key is to find investment opportunities that have these depreciation benefits. In the next email, I am going to walk you through what we look for when it comes to apartment operators that are going to take care of our investments and maximize the amount of depreciation you receive.
Cash Out Refinance.
A cash out refinance essentially turns the equity you have built up in the property into cash. The way this plays out is that you would typically refinance when you have built up enough equity to refinance into a large loan, giving you the difference between your existing loan and your new, larger one. The difference between the two is cash in your pocket, tax-free. We build substantial wealth for our investors and ourselves through this strategy.
The 1031 Exchange
The 1031 exchange is perhaps the most powerful real estate tool there is when it comes to legally avoiding and deferring taxes. Essentially, you can sell an asset and push the proceeds into another real estate asset and defer the capital gains you would pay if you were to have sold a property and pocketed the cash. In order for the “transfer” to be absolutely tax free, you have to play by the rules.
The property must be of like-kind
The property you are selling and the one you are buying with the proceeds, must be similar.
It must be an investment property or business property
This means that personal property does not qualify.
The asset you are buying must be equal or greater value than the one you are selling.
If the property you buy is of less value than the one you are selling, you will pay capital gains taxes on the difference.
The transaction must be with the same taxpayer
The tax return and the name appearing on the title of the property being sold must match the tax return and name on the title of the new property being bought.
There is a 45-day identification window
There is a 180-day Purchase Window
You can take advantage of all three of these great strategies as a passive or active investor in real estate.