In addition to making your money accountable by tracking your ROI and ROE, you want to minimize your tax exposure. This is a fundamental operating principle for all real estate investors. They understand that taxes are an obligation but not a mandate: The government wants you to pay what you owe but gives yum nay ways not t pay, at least not right away. It is really saying: “We will charge you less if you do these things.” Looking at it another way, it is saying: “We will invest in you if you do what we want you to do.”  The government wants you to invest in real estate, hold those investments, or move into bigger ones. In a sense, the government is your coinvestor. You are wise to take advantage of what it wants you to do, particularly since that is very advantageous to you as a real estate investor.

The first thing you want to do is keep a detailed and comprehensive accounting of all your expenses, including the costs you incur in lead generation and property evaluation. Almost everything you do during your acquisitions (inspections, finder’s fees, real estate commissions, etc.) represents costs you can use to offset your rental income. Most of those costs can be recaptured even years after they were incurred, at the time when you have begun to achieve positive cash flow. You certainly need to keep track of all your operating expenses while you own the properties. In addition, you can make property repairs and improvements, especially those which add value to the investment, and these expenses are also deducible against current or future income. Beyond all this you can depreciate the property; in fact, the government requires you to. It is wellworth the

expense to retain a great tax accountant who specializes in real estate investment. This person will be a key member of your Work Network. If he or she is not in your Inner Circle, your Inner Circle will help you find the best person to be your tax advisor.

The first step has been to reduce the realized income on which you will pay taxes. The second step is to reduce capital gains taxes: the amount you pay the government when you realize a profit (gain) on the sale of a property. While this profit already is taxed at a rate below most income tax rates, you can delay paying it for a very long time. The two primary ways to do this are through IRAs and 1031 exchanges. You can use your Individual Retirement Account or other tax-deferred saving plans to make and hold your real estate investments. As long as you don’t take the money out of those accounts, you do not have to pay taxes even if you achieve large amounts of equity. You can, if you choose, take that money out later, when you need the income.

In the end it’s the tax-deferred 1031 exchange that gets massive use by Real Estate Investors. This program in the IRS tax code allows you to sell and buy properties without having to declare capital gains or pay those taxes. It’s a very straightforward procedure, but it takes some planning. First, you need to hire a 1031 Qualified Intermediary before you close on the sale of one of your properties. That person will act as your guide and escrow agent as you move through the sale of one property and the purchase of the next. After the sale of your “relinquished property” you have 45 days to identify the “replacement property” and a total of 180 days to close on that second property. You want to be looking for the replacement property before or during the marketing of the property you are selling. If you find a good opportunity, you can enter into a contract with a right to assign clause if your first property does not sell or with a 1031 clause in the purchase agreement it if does.

Many people have the mistaken notion that you are exchanging your property with someone else: you take theirs, and they take yours. In some cases that can be done, but it is neither the purpose nor the requirement of a 1031 exchange. A 1031 exchange is designed for you to “exchange” one property in your portfolio (sell it) and replace it with another one that you wish to buy. It allows you to keep purchasing larger, more expensive properties without having to pay capital gains taxes on the ones you sell. This is a wonderful way to keep your money working for you.

Let’s see an example of how 1031 exchange can be done:

An out-of-town owner called me wanting to sell four properties. They were all in great condition, just needing a little paint and one new roof, and they were all fully occupied. But he had happened to get my postcard at the time he was trying to get the tenants out so he could sell them and ado a 1031 exchange into an apartment building in Florida. So he told me that if I bought all four by the date he needed to sell, he’d take 90% of their value. I negotiated him down to 82% of what they were worth, and I bought them for basically no cash out of pocket. That is, I had two people in lease-option agreements who refinanced at about that time, so I used the $130,000 I got out of those two lower-end properties as down payments on four occupied properties worth $360,000. And it was a 1031 exchange, so I didn’t pay taxes on anything.