Last week I told you that there are three types of positive cashflow Real Estate:
1. Tax Cashflow
2. Fake Cashflow
3. Real Cashflow
Today, I want to discuss the first of these … cleverly designed to make Negatively Geared real-estate look like a good deal!
In the first installment, I explained that most real-estate (especially residential real-estate, and single family homes and condos in particular) has more costs (e.g. mortgage interest, vacancies, repairs & maintenance, provisions, etc.) than income (i.e. rents), forcing us dumb investors to gamble on the future appreciation of the property … and, we can see where that has lead us!?
So, those developers and promoters with lots of real-estate that costs way too much to buy found some money to help you cover your losses and turn them into a ‘profit’ … from this, comes our first opportunity for the Holy Grail of Real Estate: Positive Cashflow property i.e. one that puts money INTO your pocket each year.
Now, I said each year for a reason: tax.
Uncle Sam will help you to help these property promoters to become rich by encouraging you to buy their overpriced, under performing real-estate! Take Scott, for example:
My wife and I have been pondering this very same topic with our rental(which was our previous home). We are negatively geared by $250.00/month on that property, have great renters that have completed their 6 month lease and are continuing to rent month to month while they continue to try and get their home in Connecticut sold, then move on to purchase their own home here in Louisville.
Money seems to be tight for them from all that I can see, however they are able to make this rent each month, so I’m a bit afraid of raising rent on them, but it really troubles me to be negatively geared for the moment. This property (according to this years filing) has given us a pretty large tax deduction, which has certainly saved us money, perhaps enough to pay us back the monthly amount we have lost to make us break even. Not to mention, it is in one of the most premiere areas of the city and has enjoyed one of the highest appreciation rates this city can offer, but as your post suggests, we don’t want to get caught up in the hope of appreciation.
As Scott has discovered the ‘secret’ is in tax-deductions …
… naturally, almost all the expenses that you have on an INVESTMENT property are tax-deductible, not just including mortgage interest (as in your own home) but, also ‘business’ expenses like repairs and maintenance … even vacancies allow you to earn a little less income, so you pay a little less tax … but these will probably not make a property cash-flow positive on their own.
Actually, the real secret is in the ‘provisions’ … a provision is a fund that you build up over time to allow you to cover major costs later (e.g. an Emergency Fund is a kind of provision).
You see, Uncle Sam allows you to ‘build up’ a fund over time to replace the building that you have on the property, and all the things that you have inside the property (e.g. stoves, lights, carpets, curtains, etc., etc.). You probably borrowed the money to buy all these things – and, are tax deducting the mortgage interest – but, the nice people at the IRS allow you to take a ‘double deduction’ in the form of a Depreciation Allowance on these items, as well.
It becomes another expense that you can get a tax deduction on, and because the property may not have enough income (hey, it’s already Negatively Geared!) you can lower your personal tax bill instead.
By paying less personal income tax, the promoters of these schemes will show you that the property can pay it’s own way (Neutrally Cashflow or Neutrally Gear) or even Positive Cashflow!
Unfortunately, it’s all on paper … and, it relies on you earning a high income … and, will probably only work for one or two properties because you won’t have enough personal tax to ‘save’ for more properties than that.
When you ‘run out’ of personal tax deductions you can’t make any more properties Tax Cashflow Positive … it’s all smoke-and-mirrors.
So, when it comes to real-estate, you want tax deductions and you want tax cashflow, but you don’t want to buy a property that only has this kind of cashflow, if you can find something better.
In the next installment, we’ll look at something even more fun: Fake Cashflow.