If you want to build true wealth, the most important mental shift you need to make concerns your taxes, and that shift is to understand that the government rewards investors.
Permit me to restate this in a different way: the government requires citizens who are willing to construct and invest in the economy. If these people were not here, our nation would be considered a third-world country. So how exactly does Grandpa encourage you to put your money to work? Incentives to pay taxes
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One of the industries with the lowest effective tax rate is real estate investment. It has reduced the amount of money that my family owes on Tax Day by thousands of dollars. Before my wife and I invested our money in real estate, we used to celebrate each tax season with a shot of hard liquor and a check for five figures to the Internal Revenue Service (IRS).
Here are three reasons why investing in real estate can also help reduce the amount of money you need to pay in taxes:
1.Real estate investments are
tax deductions
The federal government will not tax the money you use to purchase an investment property on your behalf. They are going to leave those dollars alone because they are overjoyed that you are investing in growth and working to make our cities better.
Consider the following scenario: your accountant predicts that you will owe $40,000 in federal taxes the following year, and you still have some time before the end of the calendar year. Would you rather write that check to the IRS and have that money vanish from your life forever? Or, would you rather put that money into a property that generates a steady stream of income in exchange for a monthly return on your investment? That is an obvious choice on our part. If I'm going to have to spend that $40,000 regardless, I'd much rather put it toward the latter option than the former one!
2. You will benefit from the depreciation of real estate values
Unless you rent out a portion of your home or operate a small business out of your home, you will not be able to claim any depreciation expenses for the house that you live in. My hunch is that the vast majority of you do not engage in that behavior.
But you CAN claim depreciation on your investment properties! Using certain accounting ninja tricks, such as straight line depreciation, this can be a significant deduction for your business. Your wonderful accountant will be able to assist you with this, and in certain circumstances, this may relieve you of a significant portion of the weight of your tax burden. And if your accountant isn't fantastic or has a lot of experience working with real estate investors, it might be time to look elsewhere. More on that subject to come in a later post!
3. Some personal expenses are also deductions
As the value of your real estate investments continues to rise, you might start thinking of yourself as operating a small business in the near future. To better safeguard their holdings, many investors set up limited liability companies (LLCs) or S corporations. Whether or not this is something that would work for you is something else that you and that wonderful accountant should discuss.
The advantage of running a small business is that your income can now be taxed in accordance with regulations that are more business-friendly than those that apply to larger corporations. You no longer have to pay taxes on the money you put back into your business, just like businesses don't have to pay taxes on the money they put back into their businesses. Consequently, here is the strategy: you pay as many "legitimate" expenses out of your corporation as you possibly can, and then you turn those life expenses into write-offs. Examples include your cell phone bill, your broadband, perhaps your vehicle expenses. Why would you pay those out of your personal checking account after taxes have been deducted when you could pay them out of your business account and write them off on your taxes?
Permit me to be clear: this does NOT mean that you should use money from your business account to pay for your children's summer camp and then cross your fingers and hope that the Internal Revenue Service does not audit you. No, no, no. This is not some kind of con. It is a perfectly acceptable way to make use of the tax laws in their current form.
These three tax breaks may not seem like much individually, but when added together, they can make a significant impact on your overall tax strategy. The wealthy do not build large businesses and then clench their teeth on Tax Day in the hope that everything will turn out okay. As a new investor, you now have access to the robust tax strategies that they have in place throughout the year.