Comparitive Effects of Leverage
An example of a leveraged real estate IRA purchase and the tax effects
Purchase of rental property that does not generate income in excess of $1,000 after deducting expenses
-All cash purchases of $400K
-Sells after being held one year for a 10% profit
Comparative Effects of Leverage: Single Building Purchase IRA purchases a single building for $400,000 cash.
After 1 year, the building appreciates in value by 10%, but generates no income.
Purchase of Building with 100% IRA funds $400,000
Amount Leveraged + $ 0
Amount of Rental Income generated + $ 0
Appreciation in one year + $ 40,000
Value of building sold at end of 1 year = $440,000
UDFI generated tax - $ 0
Net Return on Investment in one year = $ 40,000
Percent of Return on Investment 10%
Comparative Effects of Leverage: Multiple Building Purchase Same IRA purchases 4 buildings with leverage, at $400,000 each. Buildings produce no rental income and appreciate 10% in 1 year.
Bldg #1 Bldg #2 Bldg #3 Bldg #4 Total
IRA downpayment $100,000 $100,000 $100,000 $100,000 $400,000
Leverage $300,000 $300,000 $300,000 $300,000 $1,200,000
Total Price $400,000 $400,000 $400,000 $400,000 $1,600,000
10% apprec. $40,000 $40,000 $40,000 $40,000 $160,000
Bldgs Sold for $440,000 $440,000 $440,000 $440,000 $1,760,000
-UDFI (cap gain) -$4,500 -$4,500 -$4,500 -$4,500 -$18,000
Net Return On Investment $35,500 $35,500 $35,500 $35,500 $142,000
% Return on Investment 35.5%
Conclusion
- Leveraged transactions generate $160K gross income, less $18K capital gains tax*, for a profit of $142K and a return of 36%
- Cash purchase generates $40K gross and tax-deferred return (10% yield)
- Which would you prefer?
-36% after-tax return growing tax-deferred
-Or a 10% return growing tax-deferred *could be deferred through 1031 exchange
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