33 Guidelines for investing in real estate.......

Guideline #25:  It's an investment, not a tax shelter.

In my early days of commercial real estate, many of my compatriots were selling "tax shelters."  That was a fancy term for an investment that will likely lose money.  To be fair, back in 1980, the top marginal tax bracket in the U.S. of A. was 70%, which meant that out of each dollar earned over $215,400, the IRS took 70 cents.  (For reference sake, 2013's top bite on earned income was 39.6% on each dollar earned over $400,000).  A lot of smart, high income people figured that it was better to lose a little money on real estate, i.e. the tax shelter, and maybe build some equity, than just give the money to Uncle Sam.  I was never comfortable with that philosophy.  To my young and naive eyes, it seemed unnatural that a certain property might be worth more to one investor just because his tax bracket was higher.  The question I never got a satisfactory answer to was, "Why would you buy something you knew was going to lose money on a regular basis?"   Seemed wasteful.   As you might expect, we did not sell a lot of "investment property" back then.

When Congress passed the Economic Recovery Act of 1981, it amended the Tax Code to allow for really, really, really generous tax treatment for real estate.  As a result, real estate development went into overdrive and the value of investment real estate was (temporarily) unnaturally inflated.  In a successful attempt to curb tax shelters, peel back some of the benefits of owning investment real estate, and to "simplify the Code," Congress then passed the Tax Reform Act of 1986.  The 1986 Act both eliminate special incentives, including accelerated depreciation (ACRS), that investment real estate had briefly enjoyed, and expanded the dreaded Alternative Minimum Tax (AMT).  These simple changes instantly erased somewhere between 10% and 20% of the market value of investment real estate.  This fall in values, combined with some questionable lending practices, contributed to the savings and loan crisis of the late 1980s.

The lesson I learned from all of this was that when the government giveth, it soon finds a way to taketh away.  Basing investment decisions on the Tax Code is fraught with risk.

Today the Code appears to be neutral towards investment real estate.  Depreciation is still available as a deduction against income, however, the time periods that assets can be depreciated have been stretched to roughly mirror the actual life span of those assets.  The days of investing for tax shelter have passed by.  If they come again, remember..........be very careful.  Invest for value, not because of the Tax Code.