Maximizing Real Estate Tax-Efficiency and Cash Flow


One of the most powerful aspects of investing in real estate is the tremendous tax benefits, the primary one being depreciation. If you want to see how some of the numbers might work when considering these tax benefits, keep reading.

This Today’s Classic post is republished from The White Coat Investor. The original post can be found here. Enjoy!

I’ve been looking at lots of syndicated real estate deals over the last year or so. I have noticed a common theme among them and it finally dawned on me the reasoning behind it. These deals are generally structured to have a down payment of around 1/3, and generally last 5-7 years. The reason for this is to maximize the cash flow that can be protected from taxes by the depreciation, while still being able to take advantage of a decent amount of leverage, and having a number of years over which to spread the transaction costs.

How to Maximize Your Real Estate Investments for Tax-Efficiency and Cash Flow

Cash Flow

The best way to maximize your cash flow is simply to pay cash for the property. Using the 55% rule, about 45% of the gross rents will go toward non-mortgage expenses. So a $100,000 property with a capitalization rate of 6% (cap rate = net operating income/value of the property) would have gross rents of $10,909 and a net operating income of $6000. The best way to maximize your cash flow ($6000) is to have no mortgage expenses, i.e. to pay cash for the property.

Tax Efficiency

Likewise, the most tax-efficient property is one in which you put zero down. Not only will the expenses eat up all the gross rent and then some, but you can (and will probably have to) add money to the property, increasing the value of your investment in a very tax-efficient manner. In fact, if you really want a tax-efficient investment, you could overpay for the property too and use the losses each year and when you sell it to offset your regular income (or if you make too much, at least your other passive income.)

Getting Positive Cash Flow

However, most real estate investors don’t want to feed money into their properties. At a minimum, they want it to at least pay for itself. What is the minimum amount of money you need to put down to get that?

Well, it depends on the cap rate of the property and the terms of the loan. Let’s assume that same $100K, cap rate 6 property. Let’s assume a 5%, 30 year loan. If you put down 10%, you have a loan on $90K. Your total mortgage payments would be $5,575, so you’d be slightly cash flow positive. Your gross rents would be $10,909, your non-mortgage expenses would be $4909, and your mortgage expenses would be $5,575. You’d be left with $425, or $35 a month in positive cash flow, for a cash on cash return of 4.25%. If you only put down 3%, you would have zero cash flow and your cash on cash return would be 0%.

Maximizing Cash on Cash Return

If you put down 100%, you would have a cash on cash return of 6%. If you put down 3%, you’d have a cash on cash return of 0%. If you put down less than 3%, you’d be feeding the beast (technically a negative infinity cash on cash return). As seen below, the more you put down, the higher your cash on cash return. This simplistic example, of course, ignores the fact that if you put 20-50% down you’re going to get better mortgage terms than if you put 0-20% down.

$100,000 Cap Rate 6 Property with 5% Mortgage
Down Payment Mortgage Payment Cash Flow Cash on Cash Return
$0 $6,195.37 ($195.37) N/A
$10,000 $5,575.84 $424.16 4.2%
$20,000 $4,956.30 $1,043.70 5.2%
$30,000 $4,336.76 $1,663.24 5.5%
$40,000 $3,717.22 $2,282.78 5.7%
$50,000 $3,097.69 $2,902.31 5.8%
$60,000 $2,478.15 $3,521.85 5.9%
$70,000 $1,858.61 $4,141.39 5.9%
$80,000 $1,239.07 $4,760.93 6.0%
$90,000 $619.54 $5,380.46 6.0%
$100,000 $0.00 $6,000.00 6.0%

Random Pondering

So, if the best way to maximize cash flow is to put 100% down, and the best way to maximize tax efficiency is to put 0% down, and the best way to get the maximum cash on cash return is to put 100% down, why are all these deals structured with about 1/3 down? Perhaps its the benefit of depreciation.


Although there are several different methods of depreciation, the simplest is to simply depreciate the value of the building (not the land) over 27.5 years. So if the land on our Cap Rate 6 property is worth $30K, and the building is worth $70K, then you get to depreciate $70,000/27.5 = $2,545 per year.

That means that $2,545 of your positive cash flow PLUS the amortization on the loan (remember only the interest portion of the mortgage payment is deductible) comes to you as tax-free income. (Yes, depreciation has to be recaptured when you sell, that’s why you exchange properties until you die and pass it to your heirs with a step-up in basis.) So let’s remake the chart a bit.

So what do you see? At around 1/3 down your entire annual return is tax-free. The appreciation (if any) is tax-free until you sell (and if you exchange, eternally tax-free). The cash flow and amortization are completely off-set by the depreciation.

So what do you get? At 1/3 down, your property might be worth 2% more due to appreciation (a 6% gain on your original investment), you paid down about $1,003 on the mortgage, and you got $1,870 almost tax-free ($328 was taxable) to spend on whatever you like. Not a bad return on a $33,000 investment-14.6% pre-tax and with a 35% marginal tax rate, 14.3% after tax. Now you see why these real estate guys get all excited about this stuff.

Years Two Through Seven

So what happens in year two? Well, the mortgage is paid down a little bit more. You raised rent 2%, and depreciation stays the same. Let’s look at another chart demonstrating perhaps why these deals are often structured over 5-7 years.

Year Cash Flow ConC Int. Prin. Prin. + CF Taxable Inc Tax-free Inc After tax Ret Leverage
1 1870 5.6% 3127 1003 2873 328 1542 14.3% 3.00
2 1990 5.6% 3077 1054 3043 498 1491 13.7% 2.81
3 2112 5.7% 3024 1106 3218 673 1439 13.3% 2.64
4 2237 5.7% 2969 1162 3399 854 1383 12.8% 2.49
5 2364 5.7% 2911 1220 3584 1039 1325 12.5% 2.36
6 2494 5.7% 2850 1281 3775 1230 1264 12.1% 2.24
7 2627 5.7% 2786 1345 3971 1426 1200 11.8% 2.13


Several things to notice that happen after 5-7 years. First, the percentage of your cash flow that is taxable increases each year and at year 7, the majority is taxable. Second, your after-tax return decreases each year. This is primarily because you are becoming less and less leveraged each year.

In fact, after about 8 years, your leverage has gone from the original 3:1 to a factor of 2:1. Finally, I’ve been completely ignoring transaction costs both in doing the cash on cash returns as well as in the total returns. The more years you spread these costs over, the less of a bite into your return they take each year.

There are a couple of other factors, of course, that explain why these exchanges often happen after 5-7 years. First, investors don’t like to tie their money up forever. We’re not immortal. Second, those who are putting these deals together often get additional flat or asset-based fees for structuring the deal, buying the property, and selling the property. The more complete round trips they do, the more they get paid.

Transaction Costs

Just for fun, let’s look at the effect of transaction costs. Let’s assume transaction costs of 4% to buy (exactly the fees on a recent syndicated deal I looked at), and 5% to sell. In my experience, on a private residence 5% to buy and 10% to sell is a pretty good estimate, but with an investment property, especially a syndicated one, it would hopefully be less.

Obviously, if you can achieve lower costs, then your returns will be better. Keep in mind these percentages are based on the entire value of the property, not just your equity. So if you sold after just one year, your cash on cash return would be just 5.0%, instead of 5.7%, and your overall return would be -13%, instead of +14.3%. It would be slightly better than that after tax because you could deduct your losses!

So even though your property was cash flow positive, and appreciated while you held it, you still lost money due to your hold period being too short to make up for the transaction costs. In my $100K property example, the total round-trip transaction costs are in the $9-10K range. Spread over 7 years, it’s $1,392 per year, lowering the return by something around 4% a year.

Boosting Returns

So in the end, this Cap Rate 6 property, leveraged 3-1, ends up with an annualized return of around 10%, about the same as historical returns on stocks. If it appreciated faster, or if it had a higher Cap Rate, then your return would be a little higher.

So if you’re buying real estate expecting outsized returns, you need to do a few things to make sure it happens. First, you need to buy property with a higher cap rate than 6. Second, you need to buy property that will appreciate faster than 2% a year. Third, you could leverage it up a bit more or get better terms on the mortgage. For example, if you had a cap rate 9 property and a 3.5% mortgage, the first chart in this post would look like this:

$100,000 Cap Rate 9 Property with 3.5% Mortgage
Down Paym. Mort Paym. Cash Flow ConC Ret
$0 $5,253.27 $3,746.73 N/A
$10,000 $4,727.94 $4,272.06 42.7%
$20,000 $4,202.62 $4,797.38 24.0%
$30,000 $3,677.29 $5,322.71 17.7%
$33,333 $3,502.20 $5,497.80 16.5%
$40,000 $3,151.96 $5,848.04 14.6%
$50,000 $2,626.63 $6,373.37 12.7%
$60,000 $2,101.31 $6,898.69 11.5%
$70,000 $1,575.98 $7,424.02 10.6%
$80,000 $1,050.65 $7,949.35 9.9%
$90,000 $525.33 $8,474.67 9.4%
$100,000 $0.00 $9,000.00 9.0%

Pretty hard not to get excited about figures like that! Add in some appreciation, a little leverage, and the tax benefits from depreciation and you could make out like a bandit on a deal like that if held long enough.


Overall, I think about a third down is a pretty good balance of having positive cash flow but being able to shield most of it with depreciation. You get the benefits of leverage, while still being able to avoid being underwater even in a nasty real estate downturn. A 5-7 year holding period allows you time to spread the transaction costs over multiple years while allowing you to get out as the investment becomes less tax-efficient. However, be aware that a longer hold period may be more appropriate for your goals with the investment.

What do you think? Do you invest in real estate either directly or through a syndicated deal? How much leverage do you typically use and why? How long do you hold your investments and why? Comment below!


  1. You really know your math! I made my own pro forma in Excel once upon a time to make stuff like this easier for my wee brain.

  2. Leverage is definitely the key to maximize gains but of course being over leveraged can maximize risk as well. It’s a fine line to walk.

    I have purely invested in real estate through syndication this past year and feel like I have found my comfort zone (which I would not if I had to go out and research and buy single family homes). The key is to have some sort of real estate in your portfolio because I feel it really balances the roller coaster ride of equities and can provide a relatively safe income floor so you may not have to tap equities if there is a market correction

  3. Nice summary. We should note that the entire cash flow is tax free at any down payment less than 30%, not just when you get to 30%. If you put 10% down your entire cash flow might be tax free for 10-15 years, allowing for a longer period for appreciation to accumulate. Any depreciation you don’t use this year, because cash flow was less than depreciation, will carry forward and you will use it in later years when your cash flow exceeds your annual depreciation figure. I think you will maximize tax efficiency for a longer period by using a lower down payment.

    I think the 5-7 year turn around is the sweet spot, as nicely shown above, that the managers will show you to justify them “churning the account” to increase their profits. They need to keep making deals to keep their own cash flowing, as WCI points out.

    I’m more of a buy and hold kind of guy myself. That spreads the acquisition costs of time and money over even more years.

    Dr. Cory S. Fawcett
    Prescription for Financial Success

  4. I agree with some assumptions made within the article, but some need a bit more detail to more accurately reflect the points trying to be made.

    To me, the main take away from this article for anyone should be that the calculated use of leverage does indeed significantly impact your returns. I think most individuals that are serious about real estate in their portfolio appreciate this concept, but for those that are debt averse it is a huge concept to embrace and recognize how it affects the performance of your investments.

    For the purposes of most real estate investors, it’s kind of silly to propose the example of overbuying for a property with all cash in order to try to illustrate the example of having a negatively cash flowing property as being maximally tax efficient. That scenario is not really practical or comparable to comparing 2 CASH FLOWING properties – one either bought with leverage and the other bought with all cash. In fact, if you want to make a more fair comparison you could look at buying one $100,000 property with all cash versus buying three $100,000 properties using 3:1 leverage. Using the same loan terms and operational projections in this example, the purchase of the three leveraged properties is actually more tax efficient AND has better cash flow.

    Another significant piece of the equation that has not been considered in this scenario is the fact that most syndication deals that end up having outsized returns compared to your example have some sort of value-add component to the strategy of the investment. It is because of this that it is not just the CAP rate or “market appreciation rate” that impacts what kind of returns can be made. Indeed, if your example is referring to buying a turnkey single-family rental with no significant upside in operational efficiencies or physical aspects of the property, the overall returns will more likely mirror the projections you have shown. However, this is not the case for most syndication opportunities where the targeted properties offer an opportunity to force appreciation by improving upon operations or increasing revenues by improving the property in order to achieve higher income from rents or amenities. Because these properties have valuations based on the calculated NOI, appreciation is therefore not limited to some nominal (2%) amount over time. In other words, the summary conclusions that you need to buy a property at less than a 6 CAP or need to buy a property that appreciates greater than 2% are not necessarily accurate limitations on syndicated real estate deals.

    The other point I differ on is why these deals are projected or tend to be held for 5-7 years. For sure, part of it is that returns begin to decrease as leverage decreases as already pointed out. However, one of the main reasons is that by 5-7 years the overall plan for optimizing the value of the property as discussed above has already been played out. At that point, for the best returns you are better off exiting the property and rolling that equity into something else with another opportunity to again add value and benefit from the increased valuation. It goes without saying that of course your transactional costs make more sense when considering a longer hold time, but this is not an absolute barrier to exiting a property if indeed the investment strategy has already been played out and the value has been achieved.

    I’m admittedly a bit biased toward real estate, but this has been my experience being involved in both active and passive real estate deals.

  5. Other than using crowdsourcing sites, where do you find syndication opportunities?


  6. I have a few single family rentals and a little commercial real estate. I like real estate investing. I have been looking at crowd funding but haven’t pulled the trigger yet. I have been focused on side hustles and PE the last few years. With those starting to cashflow I’m looking to reinvest a good portion in real estate.

    Other than crowdfunding platforms how does someone get started in syndication investing? How do you conduct your due diligence on a syndicator?


    Fat fire at 45

  7. Very nice article. Very helpful. Any input regarding taxes, when you invest through crowdsourcing? If you are in the highest tax bracket, how much do you pay on the returns through them, since you dont have the option of deducting depreciation or mortgage? Thanks

  8. Very helpful article and easy to follow. Thank you for posting. Anyone have a link to a spreadsheet where I can input different variables and create tables like this? Would be very helpful when trying to analyze properties.

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