It is not that difficult–if you have access to capital. Here are the steps:
(1) Buy an apartment complex for $10,000,000 at a 4.5 percent cap rate with a 35 percent downpayment; finance $6,500,000 with an interest only loan at 3.5 percent that comes due in five years.
(2) Let’s say 35 percent of the value of the property is land and the remainder is improvements. Improvements on apartments are depreciated on a straight line basis over 27.5 years. So taxable income is 450,000-227,500 (interest) – 236,363 = -13,863 or a taxable loss.
Meanwhile, cash flow is 222,500 per year. So one gets cash while taking a tax loss.
(3) It gets better. Suppose when refinancing happens in five years, the property has gained 20 percent in value. Now one gets a 65 percent LTV loan on a $12,000,000 property–and gets to pull $1,300,000 out of the property. Suppose NOI has also gone up 20 percent. Sow now taxable income is 540,000-273,000-236,363 = 30,636.
Assume that the owner’s all in marginal tax rate is 50 percent. In exchange for a one time $1,300,000 in cash and cash flow of $267,000, the owner pays a little over $15,000 in taxes and 3.5 percent in interest on the extra money. No matter how one looks at it, this is a tax rate on cash of less than 10 percent.
It keeps going for 27.5 years, at which point the owner can defer taxes via a like-kind exchange. All of this is perfectly legal. And it explains why salaried workers pay more in taxes than owners of capital.
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