Currently, numerous media headlines warn of impending inflation. Learn how real estate protects you during inflation.
Inflation and taxes are the biggest threats to accumulating wealth.
The dollar is worth less during inflationary times. Spending more money on daily needs like groceries and gas leaves less money every month. Less to invest and less spending on enjoyable things.
Yet, wealth building suffers when you can’t invest and grow your money.
Don’t Worry! We have a solution!
Current national news media are scaring us about the misery of high inflation, labor strikes, and recession.
Most Americans pay more in taxes than for everyday necessities.
Learn how real estate investing protects you from inflation.
Real estate housing investments offer tax benefits like depreciation and business deductions.
Inflation accelerates appreciation not taxed until you sell your rental property.
Fixed-rate long-term debt on rentals that appreciate during inflation gives you added benefits.
Learn how to accelerate your depreciation using a Cost Segregation Study for greater tax benefits.
Defer your taxes when you sell by using an IRS 1031 Tax-Deferred Exchange.
Our Nation Faces High Inflation and a Recession
Current national news media reports paint a bleak outlook for the U.S. economy:
Wall Street Falls: Last week, the news media reported “Stocks fell broadly on Wall Street for another week of sizable losses”;
Global Recession: On September 16, 2022, CNN headlines screamed, “FedEx warns of a global recession”;
Labor Strikes: CNN also reported on September 17th that “Wall Street dodged a rail strike crisis, but there's trouble ahead”;
Higher Mortgage Rates: ABC News reported “US mortgage rates jump to the highest level in 14 years”;
Fed Hikes Rates: The Federal Reserve expected to hike rates even more; and
High Inflation: The U.S. inflation rate for September 2022 is 8.26%.
Don’t Worry! Read how inflation helps housing investments using current tax breaks.
Understand the Relevancy of Taxes During Inflation
A Tax Foundation study revealed that Americans lost more money paying taxes than they spent on clothing, food, and housing combined.
Taxes are becoming our largest expense!
Inflation Drives Up Wages and Earnings Leading to Higher Tax Brackets
Common logic assumes that income also increases during times of inflation. Read today’s news about labor strikes for more pay. Also, increased income results in a higher tax bracket.
For instance, If you earn $150,000 per year you might be in the 24% tax bracket. However, during inflation, you might enjoy an increased income to $200,000. Sounds great, right? Still, your higher income may put you into the 32% tax bracket. That’s because your taxes increase with your income.
An old saying goes: “You can't control inflation but you can control your taxes.”
We will show you ways to protect yourself from taxes and inflation.
How? Through real estate investments.
Find out how real estate helps hedge you against inflation and reduce taxes.
Real Estate and Inflation
Surprising to many, some investors aggressively buy real estate during inflation. Why? Because real estate is a good investment during inflationary times. As prices rise, so do real estate values.
According to Forbes, “historically, real estate does well during inflation.”
Why? As inflation forces an increase in costs, so do the rents. The results of our nationwide strikes are that wages increase. Workers will afford to pay more rent. Higher wages drive up market rents. Similarly, shorter lease terms let landlords increase rents more often. When annual leases expire, landlords can increase rents.
Understand the Concept of Debt
Real estate investors love using leverage. However, there are good and bad debts. Examples of bad debt include credit cards and paying for things you can’t afford. Good debts include debt on income-producing properties. Especially, long-term debt with a low fixed interest rate.
Long-term fixed investment debt allows you to keep your payments the same when the dollar’s power decreases. Thus, a $2,500 monthly payment on a rental unit has less impact on your bottom line. Another old saying is, “Inflation punishes savers and rewards borrowers.”
Proper planning and due diligence result in a fixed-rate long-term debt on rentals that appreciate. Thus, this becomes the best inflation hedge.
Using Real Estate Tax Deductions for Your Benefit
Let’s explore the wonderful world of real estate tax deductions. The IRS differentiates between "passive" real estate investors and "active" real estate professionals. Each one has different tax deductions.
Let's look at the two most important ones; depreciation, and general business expense deductions.
Depreciation is a huge tax benefit for real estate investors. How does depreciation work?
Housing Depreciation: “Most U.S. residential rental property is depreciated at a rate of 3.636% each year for 27.5 years.” Thus, the IRS lets investors take write-offs on paper for the buildings' purchase price over 27.5 years.
Example of Depreciation
You buy a rental property for $200,000. The land is worth $100,000 leaving $100,000 paid for the building. Depreciating $100,000 over 27.5 years results in $3,600 annual depreciation. It doesn’t matter if you paid all cash or financed the purchase 100%, the depreciation remains the same. Thus, the IRS lets you get a tax deduction on leveraged money.
Bonus: If you don’t need to use the depreciation during one tax year the IRS lets you carry forward the deduction into future years. This can offset other passive income taxes.
Extra Bonus: How to Supercharge Your Depreciation
Increase your depreciation with a Cost Segregation Study;
Rather than depreciate your rental property over 27.5 years; you
Accelerate part of your depreciation during the first few years.
How do you do this?
Start with a Cost Segregation Study which involves breaking down the value of your separate structure costs during the first few years of ownership. “The primary goal of a Cost Segregation Study is to identify all construction-related costs that can be depreciated over 5, 7, and 15 years.”
This is known as a “Bonus Depreciation”. It lets you segregate items in a building that depreciate faster than the entire building. These include plumbing fixtures and fencing; also fixtures, furniture, and equipment (FF&E) depreciated over 5 or 7 years for tax purposes.
Let’s assume you bought a $500,000 rental property with $100,000 down. The land is valued at $100,000 leaving the structure valued at $400,000. Normally, your annual depreciation is $14,500.
In the first year, your cost segregation study could accelerate the depreciation up to $120,000. This allows you to offset $120,000 against your rental income instead of only
Adding inflation to this example, if you are in the 24% tax bracket the $120,000 depreciation saves you $28,000 in taxes. If inflation increases your earnings and puts you into the 32% tax bracket you will save $38,400 ($120,000 x 32%).
Tip: If you can’t use all your depreciation in your first tax year, simply carry forward the unused depreciation into future tax years to offset all your passive income.
Therefore, you can use inflation with higher earnings to save money with the increase in your tax bracket.
How Inflation Helps Appreciation Tax Benefits
Besides depreciation, you will benefit during times of inflation because your increased appreciation is not taxed until you sell.
For example, the $500,000 property above appreciates during inflation to $750,000 leaving your $250,000 appreciation tax-free. Only when you sell will you pay taxes on your total appreciation. Yet, here are ways to avoid the capital gain tax completely by using an IRS 1031 Tax-Deferred Exchange to buy more investment properties.
Read our informative post explaining 1031 Tax-Deferred Exchanges, “How to Profit Using 1031 Exchanges”. We will teach you how Tax-Deferred Exchanges:
Allows you to defer your capital gains tax when you sell a business or investment real property. As long as you use the profits to buy more business or investment properties;
You are free to use the 1031 Exchange Law as often as you like; and
When you pass away, your heirs inherit your real properties without paying estate and capital gains taxes.
2. General Expenses Deductions
Many tax deductions exist for real estate housing investors. Depending if the IRS classifies you as either an "active" or "passive" investor, the types of deductions differ. Investopedia explains the current differences in its recent article "Rental Property Tax Deductions".
Likewise, the IRS publishes useful information about what deductions real estate rentals investors can take like:
How Real Estate Protects You During Inflation – Conclusion
Now that you learned how real estate protects you during inflation, isn’t it time to buy rental properties as a hedge against inflation?
Don’t worry about the news media scaring everyone with stories about inflation and recession. Take advantage of our troubling times.
Use inflation to your advantage to combat wealth erosion. Now that you know how to gain significant wealth during the current inflation, seek your opportunities.
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Contact us today to get the scoop on the best neighborhoods in greater San Diego for buying rental properties. Let the media continue to scare away your competition (other buyers) with inflation, labor strikes, and recession woes. Take advantage now with fewer buyers to compete for the best rental housing deals.
Steven Rich, MBA - Guest Blogger