Did you know that there are hidden benefits to investing in real estate. Even when you think you lost money on an investment. Everyone always talks about the cash flow a property makes. But even if your cash flow was negative on your investment property, meaning, you had to take money out of your own pocket to pay the bills, in the end, you didn’t, and actually made money.
Huh! Stay tuned and I’ll explain how you can make money in real estate, even when you think you didn’t.
With investing in real estate, they are a lot of hidden benefits, where we are actually making money even when we think you didn’t.
Sounds confusing, let me explain using an example.
So lets say we bought a property for 300K and rented it out for the year.
Our income let’s assume you collected for the year from our paying tenant was 19,800. After paying the expenses of 5000 associated with the property and making the monthly 1400 loan payment, we loss $2,000 over the year that the property was rented out.
This was out of pocket, out of our bank account.
However, here is where it gets interesting, where we are actually making money, even when we think you didn’t.
Due to the hidden benefits, that in the end, actually put more money in your pocket each year by investing in real estate.
Yes, even when we thought we lost $2K.
First. I’m not a licensed accountant, and I highly recommend you speak to a licensed professional to confirm this information, as well as speak to one before ever investing in real estate.
The first benefit.
Yes, we lost $2,000 out of our own pocket, however, that was after paying the mortgage payment. To determine depreciation, we need to remove the mortgage payment as we need to calculate the income. We are going to assume the property we rented out that we purchased, WHICH cost 300K. results as mentioned earlier to a $1,400 a month mortgage payment.
Sidenote, details on the mortgage, this is if we put a 20% downpayment amortized over 25 years at 5% interest.
So lets assume that leaves us with an income $14,800 for the year; net income of 19800 less expenses of 5000. Which I calculated earlier
Now, if we purchased a 300,000 home, and the land is worth $100,000, and the building $200,000, then when calculating the depreciation, and including the fees to purchase the property.
The depreciation for the year at 4% is 8213. This is subtracted from your income.
How did I get that, well here’s the breakdown.
First, in Canada, depending on the class the property is will determine how much $ you can deduct. For a class 1, which is most residential buildings, its 4%. Which what we will be using.
Also, you can’t use Capital cost allowance, which is a term used in Canada for depreciation, to create or increase a loss. So if we claimed a loss on the income, then we can’t use depreciation as well. We didn’t have a loss so we can claim depreciation.
Remember, we had a profit of 14800, because the mortgage cost is taken out.
Also, land can not depreciated, but the building can be, which is why we broke the value out for each, as well as why we included the fees incurred to purchase the building, as a portion is allocated to the cost of the building.
With all these factors considered, this is how we came up with 8213 for our capital cost allowance/ depreciation.
As you can see, where originally we would’ve had to pay taxes on 15.8K in income, with depreciation, we only pay taxes on approx. 6.5K income.
So if we take our new income and add it to say our salary income for the year, here is what you get
Now I’ve done a side by side to show you the difference if you didn’t own real estate and just took home an annual salary of 100K, and had a 40% tax rate.
So now you are probably thinking, oh great, I have to pay almost 4K more in taxes, Plus the 2K already out of my pocket. Forget that, I’m not owning real estate.
Not so fast.
Because we can further reduce our rental income, by deducting the interest, such as the interest on the mortgage, and in Canada, this can only be done on investment properties, not personal homes. As well as interest on any loan, such as a HELOC, which we used for the down payment of the property.
Lets say then over the year you had 15K in interest payments for towards your income producing investment property (1000 interest on mortgage, 250 interest on HELOC, per month). Which equals 15K
So, right now, even though you think you lost 2k out of your own pocket, and have to pay another 4K in taxes due to the income the property made.
After deducting the interest, it reduces the income taxes you pay by 6K.
So where you would’ve had to cut a check to the government for 40K on a 100K salary, by owning real estate, and by factoring in depreciation and interest, you only had to cut a check to the government for approx. 36.6K.
That’s a 3365 savings.
While originally you thought you lost 2K, you now just saved 3300 bucks out of your own pocket that you don’t have to pay in income taxes.
Now, sure, it doesn’t seem like much for all the headaches that come with owning real estate. Most people would rather do nothing and put 60K in their pocket after taxes on their 100K, whom cares about putting an extra 1300 in your pocket.
Well you should, because once we factor in the equity we’ve built up in the property, the money you made when you think you didn’t, skyrockets.
First factor, the mortgage paydown, by using someone else’s money, your renters, to pay down the mortgage, your loan. In our example, we paid approx 1000/month in the 1st year in interest on the mortgage, so the other approx. 400/month went to the principal of the mortgage, which equals almost 5000/year in equity built!
The other factor to the equity you’ve built is through appreciation of the property.
Let’s assume the average appreciation for the area was 5%. On a 300K home, that’s $15,000.
We built up then $20,000 in equity through mortgage paydown and appreciation.
So you might’ve thought you lost 2K, but really, with the tax write offs for interest, which we incurred because we leveraged a HELOC for the down payment and leveraged a bank mortgage for the balance, so none of our own money,
Along with the factoring in the depreciation the building incurred, which lowers the actual income you made, and the equity we built through paying down the mortgage and appreciation.
We actually made 23K!
Even if we made no appreciation, we still made 8K.
Plus, by utilizing debt, it allows you to avoid tax consequences if you were to sell off investments to produce cash to buy the house. This way you can keep your money invested to grow and collect dividends and interest over the past year.
This begs the question, why aren’t you investing in real estate?
You literally can grow your net worth by over 20K each year on a 300K property, and do it by leveraging other people’s money.
What are you waiting for!
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