An attractive element of
real estate investment is that it creates a paper loss when in actuality you
have gains. To understand how this can lower your taxes while increasing your
income, here’s a quick example.
|
Rental Condo
|
|
|
Rent Collected
|
$16,200
|
|
Mortgage Pmts
|
(10,000)
|
|
Assessments
|
(1,000)
|
|
Taxes
|
(3,000)
|
|
Insurance
|
(200)
|
|
Total Cashflow
|
$2,000
|
|
——————–
|
|
|
Depreciation
|
(7,000)
|
|
Total Income
|
($5,000)
|
The rental condo
produced $2,000 in income - $2,000 of real money in your pocket. When
depreciation expense is included, the condo shows a loss of $5,000. However,
the loss is a result of depreciation, a non-cash expense. What this means is
that depreciation is expensed on the income statement, but does not represent a
real cash outflow, so it creates a loss on paper despite the positive cash flow
in reality.
Now if you had 5 condos
just like this one, you have reduced your taxable income by $25,000 (the
passive rental loss limit you can deduct by law), when you have actually earned
$10,000 from your properties.
Case in point. Last
year, my salary was in the six figures. But my taxable income, due passive
rental losses and other deductions, was a mere $36K. I paid only $5K in taxes.
