Falling real estate prices may offer buying opportunities for careful investors, and tax advantages may make a good real estate investment even better. Suppose, for example, Bill Anderson buys a strip shopping center for $2 million. He makes a $400,000 down payment and borrows the remaining $1.6 million at 7 percent, with an interest-only loan.
The building’s operating income (rents paid by tenants minus expenses) might be $150,000 while Bill also pays $112,000 interest on the loan: 7 percent of $1.6 million. Therefore, Bill’s cash flow from the building is $38,000: $150,000 from operations minus the $112,000 he pays in loan interest.
Bill also is entitled to take depreciation deductions. If he deducts $80,000 for depreciation, he will have a $42,000 net loss from this investment, for tax purposes. That’s the excess of depreciation deductions over operating income. With a net loss from the deal, Bill owes no income tax on his real estate investment and keeps that $38,000 in cash-flow, tax-free.