Building & Retaining Wealth In Real Estate

In the fast-paced world of real estate, understanding how to build and retain wealth is crucial. This guide delves into essential strategies that every real estate professional should know, including the benefits of setting up S Corporations, protecting assets through estate planning, leveraging various insurance types, and maximizing tax advantages through 1031 exchanges and cost segregation. Additionally, we'll explore how adopting an investor mindset and strategic credit card usage can enhance your financial success. Real-life examples and practical advice from successful peers will illustrate these concepts and provide actionable insights.

Be the Investor, Not Just the Agent

Instead of sending great deals to investors, consider partnering with them. Control the deal and bring in investors to fund it, allowing you to share in the profits.

For example, a friend of mine used to earn a $10,000 commission by double-ending deals. He now partners with investors to flip properties. By handling the management and splitting the profits, he earns significantly more. In one scenario, he invested no money upfront, yet earned 50% of the profits, resulting in a much higher return compared to a standard commission.

This friend recently had a deal where he brought in an investor who funded the $200,000 needed for the purchase and rehab. They sold the property for $350,000, with profits reaching $75,000 after expenses. Splitting this 50/50, both parties walked away with $37,500, a far better outcome than just earning a commission.

The Importance of the Right Entity Structure

Why S Corporations Matter

Setting up an S Corporation (or an LLC with an S election) is vital for any real estate business making $50,000 or more. It helps save on self-employment taxes and offers better liability protection.

For example, if your real estate sales business has a net income of $100,000, by setting up an S Corporation, you can pay yourself a $40,000 salary and take the remaining $60,000 as a dividend at the end of the year. Structuring it this way saves the 15.3% self-employment tax on the $60,000 dividend portion of your income, saving you saving approximately $9,180 annually in self-employment taxes.

Avoid Sole Proprietorships

If your real estate business or team earns $50,000 or more, it's crucial to have your S Corporation set up before you start making significant money. Trying to set it up retroactively at the end of the year won't work; you need it in place before you actually earn the income to reap the tax benefits.

Asset Protection Strategies

Flips and Rentals

For property flips, using an S Corporation or an LLC with an S election is recommended. This shields your personal assets from potential lawsuits. If you're flipping properties, the likelihood of encountering legal issues increases. Having an S Corporation ensures that only the entity is liable, not your personal assets.

Estate Planning

Having both a will and a trust is essential to ensure your wishes are carried out and to avoid probate. Holding your primary residence in a trust and other properties in LLCs or S Corporations can offer significant protection.

We recommend setting up a trust for your primary residence to avoid probate and simplify the transition of assets to your heirs. This planning ensures that your assets are distributed according to your wishes and avoids potential estate taxes.

As morbid as it is to think or talk about, failing to plan for the inevitable means the government gets to decide what happens with your assets or children. Proper estate planning is crucial to get done ASAP if you have not already.

Essential Insurances

Life and Long-term Care Insurance

Consult your wealth advisor to determine the best life insurance policy for you. Consider long-term care insurance to cover potential future medical expenses. Life insurance not only provides for your family after your death but can also offer living benefits.

For example, some life insurance policies allow you to borrow against the cash value to invest in other ventures. Smart investors can leverage their policy to fund a new real estate investment and be a strategic tool for business growth.

Umbrella Insurance

This affordable insurance provides an extra layer of liability protection over your existing policies, covering scenarios like slander or additional auto accident costs. For instance, if your auto insurance covers up to $500,000 in damages, but an accident causes $1 million in damage, umbrella insurance can cover the remaining $500,000, protecting you from significant financial loss. Umbrella insurance is typically very inexpensive, making it a valuable addition to your overall insurance strategy.

Tax Strategies for Wealth Building

Understanding 1031 Exchanges

1031 exchanges allow you to defer taxes by reinvesting gains from sold properties into new, larger properties. This strategy, known as "swap till you drop," helps keep your wealth growing and defers paying capital gains taxes on your sales.

If you continue to do 1031 exchanges, when you ultimately pass away your heirs inherit the property at what is known as its "stepped-up basis" and would only have to pay taxes on that property when its sold for profits above that new basis which is typically the market value at the time of inheritance.

When using a 1031 exchange, it's important to follow the IRS guidelines, which include identifying a replacement property within 45 days and completing the purchase within 180 days. This careful planning ensures that you maximize your tax deferral benefits.

Depreciation and Cost Segregation

Accelerate your tax write-offs with cost segregation, which allows for significant upfront depreciation on property components. This is a powerful tool for real estate professionals to minimize taxes.

For instance, by performing a cost segregation analysis on a $1 million commercial property, my friend identified $150,000 in costs that could be depreciated over 5 years, and $250,000 in costs that could be depreciated over 15 years instead of depreciating everything over 30 years. This allowed him to take immediate tax savings and freeing up capital for further investments.

Credit Card Hacking for Business

Using the right credit cards for business expenses can lead to significant savings and rewards. For instance, Amex and Chase offer substantial points and benefits for business-related purchases.

A friend strategically uses the Amex Gold for advertising, dining, and software expenses, accumulating points that translate into travel rewards, cash back, or other perks. Using the Amex Platinum for hotels and airfare, he earns 5x points, which can be redeemed for significant savings on business travel, enhancing his overall business efficiency.

By consolidating all business expenses onto these cards, he maximizes his points and uses them for first-class flights and luxurious hotel stays, which not only saves money but also enhances his business travel experience.

Real-Life Examples and Application

Transforming a Condo into a Lake House

In 2014, a friend of mine purchased a $100,000 condo and later sold it in 2021 for $300,000, creating a $200,000 gain. By using a 1031 exchange, he reinvested these gains into a $926,000 lake house, with no out-of-pocket expenses for the down payment.

Additionally, performing a cost segregation analysis on the new property provided a $156,000 tax write-off in the first year. $49,000 was allocated to five-year property and $106,000 to 15-year property, allowing significant upfront depreciation.

Renting the property short-term generated an additional annual net income of $60,000. This example illustrates the power of leveraging tax strategies and reinvestment to grow wealth. This strategy not only deferred $200,000 in taxes but also provided a substantial tax write-off in the first year, maximizing cash flow.

Maximizing Depreciation Benefits

Doing a cost segregation study can be expensive but result in substantial tax savings using accelerated depreciation. Using traditional depreciation, a $300,000 property (with $275,000 allocated to the building, $25,000 allocated to the land) would allow for a $10,000 annual write-off over 27.5 years. However, by performing a cost segregation analysis, components of the property can be placed into shorter depreciation buckets, allowing for accelerated write-offs.

For instance, a friend allocated $49,000 to five-year property and $106,000 to 15-year property, enabling significant upfront tax deductions. This provided immediate tax relief and increased cash flow for further investments. These savings and re-investment strategies demonstrate how real estate professionals can maximize depreciation benefits to build and retain wealth effectively.

Conclusion

Building and retaining wealth in real estate requires strategic planning and the right tools. By setting up the appropriate entity structures, protecting your assets, planning your estate, utilizing tax strategies, and adopting an investor mindset, you can significantly enhance your financial success. Real-life examples demonstrate the power of these strategies in growing and preserving wealth, providing a clear roadmap for real estate professionals to follow.