I had a new investor named Sean ask me about my door knocking technique. Instead of trying to tell him, I invited him to come out with me one day. While we were out, we came across a vacant house to investigate.
In situations like these, our first course of action is to talk to the neighbors. One neighbor said they had a hard time getting in touch with the vacant owners and that they’d tried to buy the house before with no success. Laughingly they said the vacant owner said they would sell for 1.2 million dollars. This was funny because the house was probably worth $65k in its condition.
Sean and I said our goodbyes and headed back over to the vacant driveway to write up an offer to leave at the house.
Our offer read like this.
“Offer to Purchase:
To whom it may concern:
Joey English would like to purchase the property located at (the address).
Purchase price: $1,200,000 payable at $5000 down and $380 per month until paid.
If you are interested, we can close this at Terry Brumlow’s office once he’s had time to run the title and we have sufficient time to do a property inspection.
I then signed and dated the bottom.
Sean looked at me and asked if I was really going to make a million dollar offer on a $55,000 house.
I did, and here’s why: I didn’t care what the purchase price was. What I cared about was that the property would produce positive cashflow of almost $300 after all expense were paid.
“But Joey,” Sean said, “It’s a million dollars.”
Granted, it’s going to take a long time to pay off – 222 years to be exact. There’s another benefit to explore, however, that in the right circumstances might be considered an income stream. It’s called depreciation.
When you’re in business, the IRS lets you deduct certain costs incurred from conducting your trade.
If you’re a painter, for instance, you need to buy paint and paint brushes regularly. These materials are not taxable and should be deducted from income. So if you did $30k in business, but bought $10k in paint and paint brushes, then your taxable income should be only $20k.
Now if you’re a mechanic and have one of those Matco tool boxes, those things can cost $50k easily. If you make $40k a year, and you deducted all $50k for the tools, that means you’d have $10k of deductions that did you no good.
To offset this situation, the IRS lets you split up your purchase price and deduct it from your income over a period of time. That’s depreciation.
The house is the most expensive material in the real estate business. To figure out how to depreciate this cost, take the purchase price of the property, subtract the cost of land, which gives you the price of the house. Divide that by 27.5 years (the period of time the IRS set for house depreciation) and the result is your depreciable value per year.
So in the case of this house, the purchase price was one million dollars, and the land was worth about $20k. So the math looks like this: 1 million – $20k. The result divided by 27.5 years equals $35,636 in write offs per year. Assuming you’re in the 25 percent tax bracket, that’s $742.42 in tax savings per month month.
Sean said, “So with the cashflow of $300 and depreciation of $742.42, this house will make over a $1000 a month for 27.5 years?”
This million dollar offer got us immediate attention. But should you really make an offers based on depreciation? Why no! Could we have done the deal? Yes. But the main lesson here is that depreciation is a real value that goes over looked when evaluating rental property.
Joe and Ashley English buy houses and mobile homes in Northwest Georgia. For more information or to ask a question, go to www.cashflowwithjoe.com or call Joe at 678-986-6813.