Why Invest In Apartments?

(We are not CPAs or Attorneys.  Please verify what you read with your
advisors).

Unlike stocks with apartment buildings, you can
control:

  1. Choosing what property to invest in.
  2. Rental rates.
  3. Tenant selection.
  4. Expenses.
  5. Cashflow (you can predict).

IDEAL formula for Apartments

  • Income (mailbox money that comes each month)
  • Depreciation (Paper loss that IRS allows to be deducted from your active income)
  • Equity (Increases when tenants pay their rent on your mortgage)
  • Appreciation (Could be forced through increasing income and lowering expenses).
  • Leverage (Pay only 20-30 % to control own and control 100%)

So why apartments?  Top priority for people is to have a place to live.  People will take care of this before any other payment.

The tax laws are written to support those people business owners an investors who create jobs and housing.  The laws
benefit the risk takers the doers who spur the economy.

Apartments provide passive income.  Earned income is what you bring home from work in form of a paycheck.  If you
stopped going to work your earned income would end.  An income generating property is like an employee working for you.

Passive income is what comes to you from an investment such as real estate.  If you get sick and can’t earn a paycheck from your job your real estate is still working for you, most of this income may not be subject to social security and Medicare withholdings and in some cases incurs no tax at all because of your ability to depreciate a property’s value or defer claimed gains by rolling over a sale to another property.

Your reportable income on your tax return will be your rental income minus your operating expense and only the interest you paid on your deb service (not principal payments), plus two other deduction what is called “phantom deductions.”

One phantom deduction is “component depreciation” also known as “cost segregation depreciation.”  Which is the annual decline in the various components of a building like its walls, roofing, flooring, carpets, furniture, electrical, heating, plumbing systems are all depreciation. Each has a useful life or life expectancy of more than one year and will need replacement at some point.  Their cost can be capitalized and prorated over the years you own the property.   Highly recommended to do further research on Cost Segregation!

Here is more info on Cost Segregation.

Cost Segregation The IRS has a ruling that allows commercial-property-owners to increase the amount of accelerated depreciation allowed in a tax year. These savings extend back to property acquired after 1986, and they apply to new or future construction. They also extend to existing buildings under renovation, expansion and leasehold improvements, as
well as to property about to be acquired. It can also be used for financial accounting, insurance and property tax purposes. The primary goal of a cost segregation study is to identify all construction-related costs that qualify for accelerated income tax depreciation. Cost segregation is not a tax shelter and it is not tax evasion. To get the benefits, you must get a “study”, A cost-segregation study analyzes taxes and costs incurred to acquire, build or renovate commercial real estate. Experts/CPA’s conduct these services. They break down the cost for the accelerated income-tax schedules. To qualify for a cost-segregation study, property-owners must be taxpayers or must intend to pay taxes. They must also operate as a for-profit entity. Study costs can range from $10,000 to $100,000, depending on the property’s size and complexity. In many cases, however, the benefits outweigh the fees. These benefits of a Cost Segregation Study, can free up money used for other investments, paying down debt or making capital improvements.

Advantages of Cost Segregation Study:

  • Increased tax deductions for depreciation and reduces taxable income.
  • Opportunity to correct misclassified assets and claim “catch-up” tax deductions.
  • Ability to achieve faster building and acquisition cost write offs.
  • Reduction in insurance costs by identifying the components of the property that do not need to be insured.
  • Determine personal property versus real property for write off
    versus capitalization prior to construction. This allows you to write off these items opposed to capitalizing the assets. This can provide you with huge tax benefits.
  • Defers taxes on capital gain amounts until the property is sold.
  • Reduces real estate property taxes.
  • Reduces federal income tax and increases depreciation.

The other phantom deduction is “building depreciation” which means the annual decline in the useful life In all your paper loss recognized by the IRS.  There is another write off to consider “passive loss”. After you taken your rental income and deducted your operating expenses, interest on debt service and phantom deductions, the resulting income or loss is considered your passive income or passive loss.  The tax laws allow you to offset your earned income by up to 25k in passive losses from real estate as long as your adjusted gross income is below 100k.  Above the 100k level to 149,999 there is a sliding scale for what you can deduct from real estate losses.  Those with 150k or more of adjusted gross income can’t claim this deduction.

You can control the value of an apartment building.  Single family homes price is determined by what other houses in the same area sold for in the last 6-12 months.  With apartments it is about how much income the property produces. The more income, the higher the value. There could be two identical buildings next to each other and one could be more because it produces a higher net income than the other.  

People can use IRA to invest.  They don’t have to pay early withdrawal penalties to do so.  Through a self directed IRA. 

Depreciation Tax Laws allow annual depreciation to be written off as an expense item, resulting in an additional tax shelter. Depreciation is a non-cash deduction It reduces taxable income from the investment property. But, in contrast to property taxes, mortgage interest, utilities, insurance and repairs, it doesn’t require any cash outlay. The depreciation expense deduction can result in a positive cash flow property becoming a loss maker for tax purposes. Most investment properties go up in value every year, but on paper their value is going down due to depreciation.

Key real estate advantage is tax savings.  When you borrow 90% of a payment on a property, it doesn’t mean you only own 10%.  You own 100% and get 100% tax deductions.   There are 2 categories of deduction of real estate. Depreciation and passive loss.

No Capital Gains Tax: Your taxes can be deferred for life if you roll-over your capital gains to another like-kind investment property (also known as 1031 exchange).

Owning and operating an apartment, is no easy task. There are a lot of procedures on analyzing the property’s functionality. When investing in apartments your priority may be one of the three: cash flow, appreciation or tax benefits. The great thing about apartments is that you can have “forced appreciation” by making changes to the property. Having an
apartment is owning a business. So with any business, a way to increase revenue is to decrease expenses and to find more ways to earn more income.

Expenses You Can Expect While Owning an Apartment:

  • Legal services
  • Tax preparation
  • Office equipment and supplies
  • Property management
  • Maintenance
  • Credit checks
  • Advertising
  • City business tax
  • Property tax
  • Insurance
  • Capital improvements (big expenses)
  • Eviction services
  • Utilities

Increasing Occupancy by Analyzing:

  • Management
  • Comparable rents
  • Aesthetics of property
  • Retention programs
  • Review maintenance request files

Here are more specific reasons why investing in apartments is a smart move.

They are secured by their cash flow and also hazard insurance that even covers the income the properties generate if disaster hits. Are your other investments secured?

They are cash flow machines. Every month, after income is collected and bills are paid, the difference is called cash flow.
That is spendable money goes right in the investor’s pockets. Because you are spreading rent across many tenants, that income is very consistent and predictable.

Small changes can create huge increases in value through the use of leverage and the use of “multiples”. When you spread small increases across multiple tenants on a property it can create huge increases in cash flow that create even bigger increases in value.

If you raise the rent to $10 per month in a 10 unit apartment building it raises the Net Operating Income (NOI) to $12,000 per year for the building.  Do the same thing for a 50 unit apartment building and that is $60,000 increase.  

Real estate has some huge tax advantages that create “tax-advantaged income”. Through the use of depreciation, 1031
exchanges, and self-directed IRAs, you can have some of the most favorable income tax treatments of any asset class.

Every month when your tenants pay their rent, they pay off a portion of any financing used to purchase the property creating additional equity in the property as they pay down your loan.

Now here is a great strategy you can implement.

The formula, to invest like a bank.  Make your money move.

  1. Invest money into an apartment building.
  2. A couple of years later, get the original investment money back plus some extra cash through refinancing.
  3. Keep control of the apartment building.
  4. Move the money you got from refinance into another apartment building.  
  5. A couple of years later, get the investment money back through refinance again.
  6. Repeat the process