When Charles Paikert of Financial-Planning.com explored aspects of real estate investment to minimize taxes, he contacted Cardan Partners co-founding parter Marti Awad for perspective.
From Mr. Paikert’s report:
“With interest rates at extraordinary lows and many clients nervous that the multiyear rise in stocks may not be sustainable much longer, advisers are seeking other options for free cash. Real estate offers myriad ways clients can reduce taxes and grow the value of the property.”
Marti spoke with him about how some of her clients invest in real estate and potential tax ramifications.
“Colorado’s booming legal marijuana business helped one of (Marti) Awad’s clients identify a niche real estate market that also offers tax advantages.
“With cannabis growers clamoring for buildings where they can grow their potent plants, demand has soared for warehouses covering 25,000 to 100,000 square feet. But this size is too big for the small players in the warehouse business and too small for large warehouse storage companies.
“Awad’s client and a partner seized on an opportunity for profiting from price appreciation while also receiving tax-advantaged deductions.
“They decided to build two new warehouses in Denver’s Commerce City section. Each invested $500,000 and financed the balance through construction loans.
“Construction began earlier this year and is set to be completed in March. The partners expect the warehouses to have market values of $2.5 million and $4 million upon completion.
“’Current projections estimate an 8% annual cash return, net of all expenses, from the ultimate rental,’ says Awad, a founding partner of Cardan Capital Partners, in Denver. ‘The partners are actively involved in managing the business and will be able to deduct the interest on the construction loans, and later will also be able to deduct the annual warehouse depreciation and expenses for any ongoing maintenance.’
“It’s a classic win-win, Awad says. ‘The partners expect to make a profit if they sell the buildings, and will have received substantial tax benefits while they owned them,’ she explains.”
Pitfalls of using an IRA
“Given the tax benefits of investing in real estate, there is one pitfall that should be avoided, cautions Awad, the Denver adviser.
“’A lot of people ask us about buying real estate in an IRA,’ Awad says. ‘They think they can flip homes, make a quick profit and shelter the gain or use the IRA to shelter the income from rental properties.’
“While it is true that the gains and income will be tax-deferred, any related tax deductions will be lost. For example, you can’t deduct property taxes or mortgage interest, or take advantage of depreciation.
“In addition, ‘you can’t put property you already own in an IRA,’ Awad explains. ‘You must purchase new property directly for an IRA, but you won’t be able to get a traditional mortgage, and so you will likely have to pay cash. And there are rules around how much you can participate: You can’t live or work on the property, and you can’t pay for upkeep outside of the IRA.’
‘If you use funds from your taxable accounts to pay expenses like repairing the roof or replacing a dishwasher,’ she adds, ‘you can jeopardize the tax-deferred status of the IRA and trigger immediate taxation of the entire value of the IRA, plus a 10% penalty if you are under age 59 ½.’
“Clients ask Awad and her colleagues about the strategy of investing in real estate through an IRA ‘all the time,’ she says.
“Her answer is unequivocal: ‘It is just not a good idea.’
This report on Financial-Planning.com contains much more information. For a full look: