Using Leverage to Potentially Increase Your Income and Tax Benefits

Christopher Miller, MBA | Specialized Wealth Management
Originally Appeared in Apartment Management Magazine

Many investors are holding real estate they have owned for decades. The good news is that their mortgages are paid off, and they own the properties free and clear. The bad news is that these buildings are fully depreciated and their owners can no longer enjoy annual tax savings in the form of a depreciation deduction. We can take advantage of today’s low interest rates to do something about it. We will review two potential solutions today:

Solution 1 – Sell Your Paid Off Property and 1031 Exchange Into Another With Modest Leverage

Particularly if you would like to move some of your assets out of California, selling your paid-off, fully-depreciated property here and exchanging into another growing area of the country could be appealing. Every month, I read about another company fleeing California for more business friendly states. These companies may be trying to tell us something about California.

With the 1031 exchange an investor can, by following a set of rules, sell his property and exchange into another. If he follows all the guidelines correctly, he will defer any taxes that would be due. As I always say – an investor can defer these taxes forever by continuing to exchange for the rest of his life.

Let’s use an example: An investor has owned 4 units for 30 years, and they are now worth $1,500,000. His net (after all expenses) income from this property is $90,000 annually; for a cash-on-cash return of 6.5%. If he sells and exchanges into a $3,000,000 property in Texas with a moderate loan of 50%, he can enjoy a similar rate of return – potentially a better one due to the use of positive leverage. Additionally, he will acquire $1.5 million of new basis that he then can begin depreciating immediately. Similar income + more tax benefits = more money in your pocket.

Solution 2 – Leverage Your Current Property and Buy More Property With The Proceeds

Investors who don’t want to sell their properties, and who want to regain some tax benefits, may want to use this second option. Let’s say the owner above leverages his current property at 50% and receives $750,000 of proceeds. He can then pay all-cash for another investment property, and begin depreciating $750,000 right away. If he were to use moderate 50% leverage on that new property, he could buy another $1,500,000 property – for twice the depreciation.

In both examples, my hypothetical investor doubled the amount of property he owned, and increased his tax benefits an infinite amount. (The percentage increase from zero to any number can’t be calculated.)

Risk Of Leverage

Anytime you borrow money, there is increased risk. In a worst-case scenario, mortgage payments are missed and foreclosure follows. Nobody who lost their house ever expected foreclosure. On the other hand, most of those homeowners likely bought with high (80%, not a more moderate 50%) leverage. I believe that, in the right property, 50% leverage is conservative. It is a risk – but it is one that I’m personally comfortable with. If you feel the same way; perhaps my plan to increase tax benefits through leverage is worth considering. My toll-free number is (877) 313-1868.

Christopher Miller is a Managing Director with Specialized Wealth Management and specializes in tax-advantaged investments including 1031 replacement properties. Chris' real estate experience includes work in commercial appraisal, in institutional acquisitions for a national real estate syndicator and as an advisor helping clients through over four hundred and seventy five 1031 Exchanges. Chris has been featured as an expert in several industry publications and on television and earned an undergraduate business degree and an MBA emphasizing Real Estate Finance from the University of Southern California. Chris began his real estate career in 1998. Call him toll-free at (877) 313–1868.