Planned Loss or Planned Gain
December 1, 2000
Things were different then. When I began investing in real estate in the early 1980s the philosophy was to lose money and make it up on tax savings. As a matter of fact some people thought there was something wrong with you if you demanded positive cash flow.
The idea was that you had to take money out of your pocket every month over and above rent income to cover the mortgage, property taxes and insurance, plus repairs and maintenance. But in a few years you planned to actually turn a profit.
It was no accident. In the early 1980s the tax laws were geared to losing money. In fact huge real estate trusts pooled the money of doctors, lawyers and entrepreneurs—people with huge tax liabilities— to invest in all kinds of real estate with the idea that their “investment” was a tax shelter. It couldn’t help but be with the tax laws the way they were. What with a 15-year depreciation on real estate, that could include assorted schemes for accelerating the depreciation such as double declining and ACRS, there was almost no way not to show a tax loss.
All that changed with the passage of the Tax Reform Act of 1986. Depreciation had to be straight line, all the acceleration techniques went away, and you had to depreciate over 27.5 years. If you listen carefully, you can still hear the echoes of the hue and cry of the real estate investment trust investors.
However, I said at the time that it was a good thing. As long as the tax laws were written as they were, there was little incentive to raise rents. Now there was. Buying real estate exclusively for the tax breaks may have been good for the big investors, but it was hurting the smaller ones who couldn’t afford to buy much real estate if they had to take a loss every month.
Sure enough, rents went up and today it is an unusual situation where real estate investors will buy a property that doesn’t pencil out.
The point to all this is that some landlords act as if they are still operating under the rules of the 1980s. They take money out of their pockets every month, just like they would have had to under the pre-1986 tax laws, hoping to make it up on their taxes because they won’t raise their rents. You’ll never get rich in real estate doing that.
The Tax Reform Act of 1986 made owning rental real estate more like any other business. You don’t stay in business if you don’t turn a profit. We get almost all of our operating profits from our rental income. Any tax breaks we get for depreciation and other deductions are just icing on the cake.
As one of your goals for 2001 start doing the rental business in the 21st century. Think about where your rents should be and make a plan to put more money in your bank account every month. Make the old-style, planned-loss real estate investment system a relic of the 20th Century.