The BRRRR method is a popular real estate investing strategy that stands for Buy, Rehab, Rent, Refinance, and Repeat. It allows investors to leverage the equity of one property to purchase additional properties, creating a perpetual cycle of investing and generating passive income. But did you know that the BRRRR method also offers significant tax benefits? In this blog, we will explore how the BRRRR method can help you reduce your tax liability and maximize your deductions and benefits.
How the BRRRR Method Works
The BRRRR method involves five steps:
- Buy: You buy a property that is below market value and needs some repairs or upgrades. Ideally, you want to find a property that has a high potential for appreciation and rental income after renovation.
- Rehab: You renovate the property and improve its condition and value. You want to focus on cost-effective repairs that can increase the property’s appeal and functionality for tenants and appraisers. You also want to keep track of your rehab expenses, as they can be deducted from your taxable income later.
- Rent: You rent out the property to tenants and collect monthly rental income. You want to set a competitive rent price that can cover your expenses and generate positive cash flow. You also want to screen your tenants carefully and manage your property well to avoid vacancies and maintenance issues.
- Refinance: You refinance the property with a new mortgage that is based on the property’s new appraised value. The goal is to pull out as much equity as possible from the property and use it to pay off your initial financing and rehab costs. You also want to find a low-interest rate and favorable terms for your new mortgage, as it will affect your cash flow and return on investment.
- Repeat: You repeat the process with another property and use the equity from the previous property to fund your next purchase. You can scale up your portfolio and income by repeating the BRRRR method as many times as you want.
How the BRRRR Method Can Save You Taxes
The BRRRR method can help you save taxes in several ways:
- Depreciation: Depreciation is a tax deduction that allows you to write off the cost of your property over time. It is based on the assumption that your property loses value due to wear and tear. You can deduct the depreciation of your property from your rental income, reducing your taxable income and tax liability. The IRS allows you to depreciate your property over 27.5 years for residential properties and 39 years for commercial properties1. You can also use a cost segregation study to accelerate your depreciation and deduct more expenses in the earlier years of ownership2.
- Capital Gains Tax: Capital gains tax is a tax that you pay when you sell your property for a profit. The tax rate depends on how long you hold the property and your income level. If you sell your property within a year of purchase, you pay a short-term capital gains tax, which is the same as your ordinary income tax rate. If you sell your property after a year of purchase, you pay a long-term capital gains tax, which is lower than your ordinary income tax rate3. The BRRRR method can help you avoid or defer capital gains tax by holding your property for more than a year and using a 1031 exchange to swap your property for another one of equal or greater value without paying any taxes on the exchange4.
- Mortgage Interest Deduction: Mortgage interest deduction is a tax deduction that allows you to deduct the interest that you pay on your mortgage from your taxable income. It applies to both your initial financing and your refinancing. The BRRRR method can help you maximize your mortgage interest deduction by refinancing your property with a higher loan amount and a lower interest rate. This way, you can deduct more interest from your income and save more taxes.
- Property Tax Deduction: Property tax deduction is a tax deduction that allows you to deduct the property taxes that you pay on your property from your taxable income. It applies to both your local and state property taxes. The BRRRR method can help you lower your property tax deduction by buying a property that is below market value and appealing to the tax assessor to lower your assessed value based on your purchase price. This way, you can pay less property taxes and deduct less from your income, which can be beneficial if you are subject to the state and local tax (SALT) deduction limit of $10,000 per year.
The BRRRR method is not only a powerful real estate investing strategy that can help you grow your portfolio and income, but also a tax-efficient strategy that can help you save taxes and maximize your deductions and benefits. By following the BRRRR method, you can take advantage of depreciation, capital gains tax, mortgage interest deduction, and property tax deduction to reduce your tax liability and increase your cash flow and return on investment. However, you should always consult with a tax professional before implementing the BRRRR method, as tax laws and regulations may vary depending on your location and situation.