A Canadian friend of mine started his real estate investment portfolio in 1986 by buying a home, fixing it up, renting it and then continued investing by trading up to larger real estate investments.
His last purchase was a 348-unit apartment building, purchased for $56 million.
How did he do it and how does the government help? (That's right, the government will help!)
Investment real estate allows investors to tax shelter their profits in two ways -- depreciation and a 1031 exchange.
If you own an investment property for example, the IRS allows you to depreciate the property every year and take that amount off your federal income tax return.
Residential property can be depreciated more than 27 years and commercial property more than 39 years.
For example, if you purchased a residential rental property worth $200,000, and assuming the underlying land is worth $40,000, you would have an asset of $160,000. This amount could be depreciated over 27 years (the land cannot be depreciated).
Each year you held the property, you could take a depreciation deduction of $5,818 off your federal income tax return.
If you held the investment property for the required amount of time to qualify for a tax rate under the capital gains statute, you would only pay 15 percent of the federal income tax on the profits and you would pay tax on the amount that was depreciated when the property is sold.
However, how can you avoid federal income tax forever?
The government has allowed anyone to use a vehicle called the 1031 exchange.
The short explanation.
If you exchange a property for a similar property, there is not a charge for income tax.
Most investors will increase the value of their holdings as my friend did, and, over a period of time, increase the value of their real estate investment portfolio.
Lastly, Uncle Sam wants his due when we leave this world.
However, at the time of our passing, our heirs get what's called a, "stepped up value," in our assets.
In other words, the property is passed on to the heirs, at the value at the time of death.
Therefore, our heirs can sell the property and possibly be free of a income tax burden (although there could be inheritance taxes).
This is the simple, condensed explanation of a procedure used by many investors.
The following caveat always applies: before investing, check with your attorney, accountant and professional real estate agent educated in the above processes.
Ray Pugel is the designated broker for Coldwell Banker Bishop Realty. For more information, call (928) 474-2216.