August 23, 2009

Real estate, capital gains, & deferred taxes

Just as there are opportunities in the stock market today, there are also several opportunities in real estate as well - where one can buy properties at a low price and invest for capital gains and/or for cash flow. But just as you eventually need an exit strategy for your investments in the stock market, you also need an exit strategy for real estate.

Take, for example, Shannon Banks who owns an investment property in the form of 2 duplexes with a value of $219,000 each, or a total of $438,000. After a down payment of $100,000, Shannon owes a total of $338,000 in loans for these properties that she bought in March 2009. Since each duplex can house 2 families each, she decides to rent out all 4 units for $700/month.

As the economy regains traction and the housing market stabilizes, it is estimated that in year 2011 the value of Shannon's duplexes will appreciate to a total of $620,000. Let's fast-forward and say it is now year 2011. Shannon owes approximately $315,000 on her property which is now valued $620,000 - which means she has approximately $305,000 of equity in her duplexes.

Let's say instead of selling her duplexes for a profit and paying fees and taxes on the sale of her investment, Shannon refinances to take advantage of the equity in her investment property. The bank gives her a new loan for $550,000. By refinancing, Shannon defers her capital gains taxes and pays off her original loan of $315,000 and pockets the $235,000. Since Shannon did not yet sell the property, she gets to defer her capital gains taxes until a later date.

So now Shannon can use her $235,000 to purchase another property that she can use to rent out and increase her already $2,800/month income, or she can invest this money into the stock market and not have to worry about taxes until she decides to either take her money out of the market, or decides to sell her duplexes.

This is smart money. Shannon is using her money to work for her, instead of her working for it! By deferring her capital gains tax to a later date - she ultimately pays less taxes. Why? Because of the time value of money. If Shannon defers her taxes to 30 years from today - the real value of what she pays in the future will be less than if she sold her property and paid taxes today.

Work smarter. Think harder.


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