Today’s REI Classroom Lesson
Blake Yarborough explains some mistakes people are making when filing their taxes. One major mistake made is utilizing expenses instead of capitalization.
REI Classroom Summary
If you’re able to depreciate an item over time instead of all at once, there are benefits to this that can help you be able to buy more properties.
Listen to this REI Classroom Lesson
Real Estate Investing Classroom Show Transcripts:
Mike: Welcome back to the flipnerd.com REI Classroom where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.
Blake: This is Blake Yarborough with Capital Concepts, this week’s host of flipnerd.com. Today I’d like to talk about taxes. Think before you file.
Mike: This REI Classroom real estate lesson is sponsored by theinvestormachine.com, FlipNerd’s private investor coaching program and your blueprint to investing success.
Blake: I’ve been a lender for 19 years now, I’ve seen all kinds of things. I’m also an investor myself, so I’m cognizant of this topic before I file my taxes. So there’s many mistakes I see people make and what that is is they start buying properties and then their CPA expenses everything, a roof, all the appliances, all the stuff, AC, they expense it for a year one loss. In fact, what they should do is be capitalizing that expense and the difference is, if you expense it, truly expense it, you’re writing it all off Year 1 like a business operating expense.
Where a capitalize expense, you take it over common. For instance, water heater, let’s say or appliances, that’s typically you can take that over five years. A five year depreciation instead of Year 1. So you do get your depreciation over time but it doesn’t negatively affect your income and your debt ratio quite as much as if you took it all at once. So if you wrote it all off at once at a true expense, then it looks you’re terrible at running real estate. Why would we give you more money? How do we know this won’t be the same expense every year?
If you talk to bigger apartment owners, stuff like that, they capitalize their expenses so their financials look good. Really, that’s the way you’re supposed to do it. Where I see a high incidence of people that truly expense things that they should capitalize and then they come to me and they want to blame their CPA, but really, they have themselves to blame because they were too afraid of their tax bill or tax consequence, if you will, of capitalizing some of the expenses and have a little bit of higher tax amount.
The thing is I’ve always thought it’s okay if I pay a little bit more in taxes if it lets me a buy a lot more property. So that’s one of things to me that has really helped me succeed in buying a very large portfolio. On the property side, I’ve never had a bank tell me no. Financials look good because I capitalize that on expense, I buy good cash flowing properties. So that’s one main topic.
Another one is, a lot of times people don’t want to depreciate, but they depreciate, well first of all you can’t depreciate your house, I mean, the land, but you can depreciate “the improvements” quote/unquote. But very few people break it down cost segregation of the different items like appliances, AC system, and other items throughout the house that you can depreciate over the useful life where some people just appreciate it over 27 and a half years. So if you tweak your depreciation, give a little bit more time to it, it will give you the extra write-offs and we can add that depreciation back into your total income for your approval for a conventional loan or portfolio loan. We can add back depreciation, we can’t add back expenses, there’s a difference.
The other thing is that we see people messing up or not messing up, but having issues with this, we’ve got your schedule E as your pass, your rental property it it’s in an LLC, it’s typically going to be on that. We discuss that, how to handle that, capitalize versus expense. Another area where people have an issue in they don’t . . . it catches them off guard.
So they may be working with the company and they filed a few thousand dollars unreimbursed expenses. It’s a 21006 unreimbursed expenses. We have to account that against you and that affects your debt ratio. Another is Schedule C income if you’re self-employed.
Just always be aware of the taxes and the tax consequences of your write-offs when you’re trying to qualify for mortgages. Once again this is Blake Yarborough with capital concepts signing off for flipnerd.com. Thank you very much.
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