How to make TAX FREE MONEY in Real Estate

What's up you guys, it's Graham here. So one of the questions I get asked a lot is how to make tax-free money in real estate. Now, because this is a subject that so many people get confused on, I wanted to make a video breaking it down exactly how to do it and exactly how I do it. So hopefully, it'll make sense to you.

Here's a very broad and simple example just to show you the numbers. You buy a property for $100,000. You spend twenty thousand dollars fixing it up. Now the property is worth a hundred and seventy thousand dollars. This means that you've just made fifty thousand dollars in equity in the property. This is basically your $100,000 price plus the twenty thousand you put in. It's now worth a hundred and seventy, and the difference between that is fifty thousand dollars. There's your equity.

So what is equity then? Equity is just an unrealized gain. Like if you had bought a stock at one hundred dollars and now it's worth one hundred and fifty, that is an unrealized gain until you sell it. So what does an unrealized gain mean? All that means is that you haven't yet sold the asset. What is an asset? Google it.

Now here's where things get interesting. You now have an unrealized gain in real estate, which means that you can now go and borrow against the equity in your home. So by using our last example of having fifty thousand dollars extra in equity, you could then go and borrow against that fifty thousand dollars using that equity as collateral.

Now, the way taxes work is that you're only taxed when you sell the property. Same thing like when you buy a stock or any sort of cryptocurrency; you only pay taxes when you sell and when you realize those profits. So if you made a $50,000 gain by selling the property, that is treated as income, and you would pay taxes on that. But if you get a loan, even if you end up with more money back in the bank than you started with, the IRS does not count that as income. That is just a shift in assets.

Now, because there's only a shift between your assets and debt and not a realized gain that increases your net worth, the IRS does not treat this money that you get from a loan as taxable income. So when you receive cash out in a refinance, the IRS doesn't see that as income because technically it's a loan that you have to pay back, and you haven't really made any money. But you kind of have.

Sort of the thing is, since you're borrowing against the equity in your home, you do technically have to pay it back. But this money can be a write-off against your rental income, and it could also be a write-off against your personal income depending on how you use it. This frees up the money that you would have just doing nothing in a property and allows you to then go and invest in.

For instance, if you're borrowing money at a 4% interest rate, but your money makes you elsewhere 10%, this means that you can profit on the difference and net an extra 6% just by pulling out your money and investing it instead.

Typically, banks will finance up to 80 percent of a property's value depending on if it's a primary residence or an investment property. This means that on a million-dollar property, you can get up to $800,000 tax-free as a loan.

So usually, any income you would make in real estate once you sell is going to be taxed. So if you made $100,000 from the sale of a property, you might have to pay thirty or forty percent taxes on that. Or you can just borrow against that equity, pull out the money anyway, and use those proceeds tax-free. You're pretty much just avoiding the taxable income entirely.

So now I'm gonna throw out some rough numbers from my last deal. I'm in it six hundred and fifty thousand dollars, and I can probably get it appraised right now for eight hundred and fifty thousand dollars, which means in equity I've made about two hundred thousand dollars. Now if I were to go and sell the property, I would be left with about a hundred and fifty thousand dollars after my closing costs.

Then after paying taxes on my hundred and fifty thousand dollars because of California and because of my tax bracket, I would probably be left with about eighty-five thousand dollars after tax. That's from a two hundred thousand dollar gain in equity in my property, which isn't bad for a few months of work. But it's only eighty-five thousand dollars instead of two hundred thousand dollars.

Now in the other scenario, I can then go and borrow up to 80 percent of the two hundred thousand, which is a hundred and sixty thousand dollars. I can pull out completely tax-free, probably more like a hundred and fifty thousand dollars once you account for random bank fees and refinance costs. But still, a hundred and fifty thousand dollar loan tax-free or $85,000 after paying taxes and closing costs and everything else that comes along with selling a property.

Keep in mind that a hundred and fifty thousand dollars I would pull out is never counted as income. But like I said, this is technically a loan, and you're gonna have to eventually pay it back. So it's essential that you don't go and do something stupid with it, like go on a vacation, buy a new flat screen TV, or buy all these things and then just be left with a higher mortgage every month.

It's essential that instead, ideally, you go and invest that money in the profit difference. The entire purpose of doing this should be to use that money to invest it in other areas that get you a higher return than just sitting in a property earning nothing. And it's also really important that the refinance property should generate enough income to support the higher monthly payment that's calculated in your loan.

If it doesn't cash flow with a new loan, this gets extremely risky, and you start to get into over-leveraged territory where you're teetering on the brink of just not being able to pay back that loan. Ideally, you should never do this if the properties aren't cash flowing and you don't have the income to support those payments. But if used correctly, this is an amazing way to speed up the process of getting wealth.

This is often why you hear many people say in real estate, "use other people's money," because other people's money is generally going to be lent to you at a lower interest rate than what you could make with your investments. So again, in my example, if interest is 4% but you can make 10% over here, it makes sense to make that 10%, pay the 4% interest every year, and then profit the difference of 6% per year.

This is what's known as a cash-out refinance and how you can use the equity as tax-free money in real estate. This is also what's known as the BRRRR method of real estate investing, which stands for buy, renovate, rent, refinance, repeat. It's a way of cashing out of a property to reinvest those proceeds in another property tax-free without ever having to sell.

Then you continue investing in more properties to generate more income that supports more properties, and then you keep doing this. So each property you buy and renovate produces equity that you can then go and borrow against to use to buy another property that provides equity that you can go and borrow against, and so on and so on.

So on, and I'll do more videos in the future about the BRRRR method of real estate investing because that's the method that I use as well. But in a nutshell, broken down very simply, here is what it is: You buy a property for $100,000, spend $20,000 fixing it up. You're in it a hundred and twenty thousand, and it's now worth a hundred and fifty thousand.

This means that you now have thirty thousand dollars in equity in this property that you can refinance and pull out money from tax-free. So in this scenario, you've invested forty thousand dollars, and you've made thirty thousand dollars in equity.

Let's also assume for random purposes you can rent the house out for twelve hundred dollars a month. You then refinance that property. It's worth a hundred and fifty thousand dollars, and you pull out 80% of the equity in that property. So eighty percent of the one hundred and fifty thousand dollar value of the property is a hundred and twenty thousand dollars.

Now your original loan amount when you bought the house was only eighty thousand dollars because you bought it for a hundred thousand dollars with 20% down. This means that you just got back forty thousand dollars in your pocket from refinancing a property with an additional thirty thousand dollars of new equity in the property.

So you essentially just doubled your investment and got a cash flowing property. Then you use this forty thousand dollars to go and buy something else, and you repeat this multiple times over the course of years or decades. I like this method a lot because it assumes a very long-term approach, and as long as the property can cash flow with a bit of a buffer, I think it's gonna be doing really well over the long term.

But like I said, I'll get into this in a future video going into the BRRRR method of real estate investing and what I've done and what I look for. But I wanted to make this video just for the purposes of explaining what a cash-out refinance is and how you can pull out tax-free money in real estate and exactly what I do and a little bit about how I invest in real estate as well.

So I hope this made sense and I hope I didn't confuse a whole bunch of people. I try to break it down as simply as I probably could. But if you have any questions, feel free to comment down below, let me know your thoughts. And as always, you guys, thank you so much for watching. If you haven't already subscribed and you want more real estate videos, make sure to click the subscribe button and also feel free to smash that notification bell so YouTube notifies you anytime I upload a video.

Also, feel free to add me on the Snapchats and Instagram. I post there pretty much daily, so if you want to be a part of it on one of those, or if you're a real fan of both of those, that would be great. Thank you again for watching, and until next time.

So before I finish this off, I have been asked all the time to give an office tour. So now is that time! I will give you a tour of the Graham Stephan office. We're gonna flip this camera. Let me show you around.

Here's what we have working here. I have two French doors to go to the backyard, but I have these blackout curtains here. So basically this blocks all of the light, and this could be, by the way, like daytime, like right outside, and this place would look exactly like this. I have everything blacked out here, which is kind of nice.

By the way, I got this rug from selectrugs.com; they hooked it up. It is epic looking. It's like this cool dark blue color. Love this! This is the office setup here. So I got, you know, two chairs, which nobody ever really sits in, but they look cool. An aviator-looking desk and then a dinosaur skull, and then these cool pieces. Like it's supposed to be a Banksy slash Alec Monopoly. I like it; I think it's kind of cool.

And then I got the car right next to it. So this is my garage as well, but the car is used in here too as like, you know, half to be garage, half as a cool backdrop. Now this paint that I used here is like this really cool matte black paint. If you touch it, it leaves little prints on it. This is the toughest thing to maintain. If it gets dust on it or whatever, you can't just wipe it off. You have to use like a damp cloth to keep this thing clean.

Honestly, it's not very practical. These lights, I got three string lights from Amazon with these cool Edison bulbs. I wired them across the beam here, and then they go to this little outlet right here. The cool thing with this outlet that I absolutely love is that I got one of these old switch chairs.

So if you want to go and dim the lights, you can, or if you just flip them on. This is where it starts to look a little messy. I use some extra boxes here, and I did what I could to black out the light. I realized anytime I want to film during the day, I can't because the light comes in through here. So I basically just had to go and black all of this out.

I need to get more of these home things to these; they actually do an amazing job, but I just need to get more of them. Eventually, I want to cover the entire door in this, and then I also have more up here as well, and it really helps deaden sound. But yes, excuse this; I got to make this a little bit more presentable.

But anyway, guys, it's like that's, uh, this is the office setup, and this is what I use. Oh, and then everyone who asked about my camera: Canon 70D, Sigma 1.8 art lens, this thing is amazing! Comic ax wireless mic transmitter here; there's a little mic, and that just goes on there. And yeah, I'm sure they do epic! You guys!