Jim Dahle explains how depreciation losses flow through K1 forms from real estate investments, and how those losses offset capital gains when you sell. A key strategy for reducing your tax bill on real estate fund profits.
Let's talk a little bit about taxes for a minute. And I had the same experience as basically what you guys describe. When someone invests in the fund, you.
Get a big, huge.
When you're Investing on the K1 side, you get a big, huge depreciation loss passed through to you in the year that you invest. Can you talk a little bit about what happens when one can't use that loss? They don't have enough passive income to use that loss to offset it. What happens to that loss?
So here's the secret sauce on the tax side. So, you know, we create losses, but the art of not paying taxes in real estate is to never stop investing. And that's not a sales pitch to get you to invest more. That's what I do. I have about 1% of my net worth in the stock market. I know I can make money in real estate, so I'm investing in all our stuff. And I probably am the biggest investor of anybody anywhere by far. But in any case, the art of not paying taxes in real estate is never stop investing. And so what happens is if you create, let's say somebody invests $400,000, so they get a $200,000 ordinary loss, but because the passive loss rules, it sits there and they can't use it. But however, fast forward four years from now, we sell an asset and let's say I'll make the numbers a little bigger to help get the example across. Let's say we trigger 100 grand of cap gain income to a doctor. So you got 200 grand of losses before, you now give them 100 grand cap gain income, and you trigger 100 grand cap gain income. But the crazy thing is you're not gonna have to write a check to the government. We're actually gonna get you a refund. And the reason we get you a refund, because the cap 100 grand of cap gain income that you get is a passive cap gain. It now allows the use of 100 grand of those ordinary losses we gave you before. And if you add 100 grand negative with 100 grand positive, that adds up to zero. So your impact on your adjusted gross income, your impact on your taxable income is zero. However, once that 100 grand of ordinary loss and cap gain get into your return, the 100 grand of ordinary is now allowed because you have 100 grand cap gain income. And the 100 grand of ordinary losses can offset your doctor income, which is taxed at the highest rates possible. And if this make the math easy, it says 50% tax rate. So then that 100 grand loss gets you $50,000 refund on the ordinary losses, and the 100 grand cap gain goes to cap gain rate. So make the math simple, say 30%. So 30% of 100 grand is 30,000 in cap gain tax. So the net result is actually a $20,000 refund by us triggering you 100 grand cat gain income. So rather than you writing a check to the government because we triggered gain, you actually are getting a refund. So it's very counterintuitive. So the beautiful thing, if you Invest in Fund 2, 3, 4, 5, 6, when we start selling assets in Fund 2, you can use those losses that the new losses are created in fund 4, 5, 6, you can use those losses to offset the cap gain from Fund 2 and 3 from prior sales, and you actually get a refund, even though we're allocating you gain. And if you keep investing, you keep triggering those cat, those losses offset the cap gains. And it's just a beautiful thing. And that's when I say, when we're adding another one and a half to 2% and you're all in returns, that gets back to this tax rate differential between the ordinary rates and cap gain rates. And this is permanent. This is not just a timing difference for the government. This money is forever in your pocket. The government's never getting it, never, never taken it back from you. You forever get it. And I think that adds again, like 1.5% per year and additional savings to you on your equity investment if you're taxed at the highest ordinary rates. As a doctor, the hosts of the.
White Coat Investor are not licensed accountants, attorneys or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.
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