CPA Corner: Real Estate Write Offs and Capital Gains
February 20th, 2009 categories: Seller Financing
“I’m proud to pay taxes in the United States; the only thing is, I could be just as proud for half the money.” - Arthur Godfrey
Have you ever heard someone say “I can write this off” or “I’ll just write it off”, and wondered what they were talking about? They were talking about a tax deduction. A tax deduction or “write-off” is a powerful financial tool that most people have not been taught to utilize.
Why should I care?
To calculate out how much money you’re really making you need to understand taxes. Would you rather make $80 and pay $20 in taxes or make $100 and pay $50 in taxes? You’d rather make the $80 right? This illustrates a simple point: always consider the tax consequences of what you’re doing with your money.
Ok fine, so what is a write-off?
A write-off is an expense that reduces your taxable income. In other words you do not pay taxes on your total income; you pay taxes on your income minus your deductible expenses.
$50,000 (income)
- $20,000 (expenses/write-off)
= $30,000(taxable income)
For example, lets say you make $50,000 a year and you are able to deduct $20,000 in business expenses (things like a home office, wear and tear on your car, computer equipment, phone, etc).
That $20,000, that’s your write-off.
What if I didn’t use the write-off?
Assuming you’re in the 30% tax bracket if you don’t deduct your expenses you pay $15,000 ($50,000 x 30%) in taxes, however if you do deduct your expenses you only pay $9,000 ($30,000 x 30%) in taxes.
Taxes paid with your write off = $9,000
Taxes paid without your write off = $15,000
That’s savings of $6,000, or the equivalent of a $8,571 raise at your work.
Another way to think about it.
You might notice that the $6,000 in tax savings is 30% of the $20,000 in deductions you took ($6,000 = $20,000 x 30%). In other words for each $1 you are “writing-off” you are saving 30 cents in taxes. Or to put it another way, everything you purchase is actually 30% cheaper if you are able to write it off.
This example is for the purpose of illustration; you should adjust this example to your personal tax rate and consult an account for a list of acceptable deductions.
Real Estate
What does this have to do with real estate?
Once you own a piece of investment real estate you are now a small business owner. There are many tax benefits available to small business owners in addition to the tax benefits available to real estate owners, such as depreciation on the property, avoiding capital gains with a 1031 exchange, and of course the ability to write off all expenses incurred as a result of owning the property.
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