3 ways to manage income with real estate

Scott Anderson

by Scott Anderson
Cash Cow Farmer Blog

Whether it’s farmland, commercial, or residential real estate, there are lot of income management techniques that real estate is good for.

Last week, we talked about managing income. We’re revisiting that topic, but this time specifically around real estate.

Today, we’ll be focusing on the tax advantages of real estate, which I learned from Paul Moore’s book “The Perfect Investment,” as well as a few real estate deals of my own.

1. Passive losses through depreciation

Unfortunately, we can’t depreciate farmland, so farmland doesn’t apply here. Still, farmers can use this option for other real estate investments.

Let’s say you buy a commercial multifamily apartment complex as an investor or partnering investor. Everything’s depreciable: the furnishings, the parking lot, the apartment building, and more. When you buy that asset, you’re depreciating everything a few years later; you have the depreciation expense.

The depreciation expense and the operating costs are generally higher than the actual revenues coming from rents. And when you have expenses higher than rents, you don’t have to pay taxes on that. The depreciation is not actually a cash cost: it’s just a removal of the asset value over time. You’re not paying it every month.

You can actually offset most of the income you get from rental property because of depreciation and operating expenses, which means most of that income will be tax-free.

2. Reverse mortgage

When you own land or other real estate free and clear, it’s possible to take out a “reverse mortgage” on the land. It’s 100% tax free, plus you can deduct the interest.

Let’s say you buy $1 million in farmland. Over time, that land either appreciates or you pay down the debt and you have equity.

If you have a million-dollar land and half a million dollars in debt that you’re paying down over time, you can go out and refinance that property. This is called a “reverse mortgage.” You can refinance it up to its asset value—$1 million—and put that money in your pocket, tax-free.

That’s half a million in cash you’ve got for other investments, tax-free. And again, you can deduct the interest.

3. 1031 exchange

Generally, when you sell real estate, it’s appreciated from the value you bought it at. You have to pay capital gains tax on assets on which you’ve realized the appreciated value. But you can do a 1031 exchange to counteract that.

I did this last year when I bought some farmland from my grandma, who’s 91 now. She grew up on the land, and her base was basically nothing: let’s say roughly $500/acre. When I bought that land from her for around $3,000/acre, she would have had to pay capital gains on $2,500/acre, which is about 20%. Huge.

So she sells me the farmland, and the money goes to an escrow agency. Within six months, you have to repurchase more real estate, and you can actually pass along that basis to future real estate.

You can do that forever, as long as the new purchase is within six months of liquidating the old asset. If somebody comes and says they want to buy your real estate, you’ll have to go out and find something to purchase in exchange.

It’s a bit of work, but you never have to pay capital gains tax. When you pass away, the basis is reset for your heirs.

Let’s say my grandma bought other real estate for the same price. She had a $500 basis and bought land for $3,000. She basically kicked the can down the road.

If she passes away and the market is $4,000, because everything is in a 1031 exchange, if my dad inherits it it’ll be at whatever the market is at. My dad’s new basis is not $500, but $4,000 or whatever the market was when grandma passed.

Conclusion

I really think you should read Paul’s book. It’s an easy read and pretty short. There are so many ways to help yourself manage your income; it’s just a matter of learning all the tips available.

This post was based on an episode of the Cash Cow Farmer Podcast. To hear more content like this in audio form, subscribe to the show at http://apple.co/1VkNGbU.