Instead of having a loss that saves tax, Ben now
has to pay tax.
In order to calculate his net benefits, Ben
adds his cash flow plus principal reduction,
then subtracts the tax he has to pay. If he divides these current net benefits by his original
$10,000 investment, the rate of return might
still look good. But here’s the key point: Ben’s
investment is not the amount he originally invested sixteen years ago. Instead, his investment is the amount he could get out of the
property if he disposed of it today.
For the sake of this example, assume Ben’s
loan has been paid down significantly over the
years and the property has increased in value.
Let’s say he could sell the rental property today
and walk out of the closing with net proceeds
of $80,000. If that’s the case, Ben doesn’t have
$10,000 invested, he has $80,000 invested.
If he divides his current net benefits by
$80,000 his return on equity is probably very
low. As equity grows, return on equity usually
falls.
Ben should ask himself, “Could my $80,000
equity do better if it was invested in a different property?” If the answer is “yes,” he should
move his equity. The best way to move equity
is by doing a 1031 exchange. Exchanging allows investors to move their net equity from
one property to another without paying tax.
MIREALTOR® | JUNE 2014
20
Therefore, if Ben wants to retain his membership in the “investment genius” club, he’ll
exchange the equity into a different property
– or properties – and re-boot his rate of return.
A successful investor’s goal is to main Z[