What are the benefits to purchasing investment property?
Investing in vacation rentals can bring significant returns and personal enjoyment. You have complete control (and use!) over your investment, unlike stocks or mutual funds. Owning vacation rental(s) will bring constant passive income, which will allow you to retire, pay for college, increase savings or supplement your income. Investing in vacation rentals will minimize concerns about your current income or capital running out if your outgrow them. If you follow a conservative, long-term approach to investing, you will have more money coming in from rentals than from your day job sooner than you think!
There are four primary benefits to investing in real estate:
1. The first of these is cash flow. What is cash flow exactly? Well, to put it in simplest terms, cash flow is what money you have left over after the mortgages, the taxes, and the insurance have been paid. Again, the tenant pays you rent, and that money pays off these items. Whatever is left over goes into your pocket……that is cash flow.
2. Though many people buy rental property for cash flow, the real benefits that can build your net worth lie elsewhere. The second main benefit from buying rental property is the tax shelter that it creates for you. What does this mean exactly? Well, each time you buy a residential rental property, the IRS allows you to depreciate that property over 27.5 years. In other words, you can take this depreciation expense against your active income from your job. Let’s use a quick example:
Say you buy a $400,000 rental property. Again, the IRS lets you depreciate the building, not the land. Normally, 85% of the purchase price is used to determine the building, the physical house’s value. In this example, the IRS lets you depreciate $340,000 (the property) over 27.5 years. This is equal to $12,362 per year you can take a depreciation expense against your active income. In other words, say you make $80,000 in income from your job. Now, take $80,000 minus $12,362, which gives you $67,638. Now this is the income that you pay income tax on, $67,638, not $80,000 (which you actually made.)
You can see how by buying this one property, you have reduced your taxable income significantly. As you can guess, if you buy two houses, this number doubles, three, triples, etc. A real estate investor can usually take up to a max of $25,000 in depreciation expense each year. For those who qualify as a “real estate professional” through the IRS definition, this can be an unlimited number. Please be sure to talk with your CPA to find out how the numbers will play out in your personal situation.
It is important to remember however that the above examples are tax deferrals. If you sell the property, you do have to recapture this tax. However, many real estate investors use a 1031 exchange to continue to defer this tax.
3. The third main benefit from owning rental property is appreciation. As we know, not all debt is bad debt. In fact, many say that real estate debt is the best type of debt to have, for it is potentially appreciating debt. Again, your home may not appreciate at 10%, or even 5% every year, but at the very least, it should go up over time. This is the area that most real estate investors build their long-term wealth. Buy the properties, and then hold them.
Time for another quick example: say you buy a rental home totaling $400,000. Now let’s say that home appreciates 2% a year over 10 years. You now have a home that is worth $488,561. You now have $88,561 in equity by simply buying a house and holding onto it. Remember however, equity is not cash in your pocket. It is a number on your balance sheet. If you wanted to sell the investment property, you would have selling expenses of course which would reduce the above numbers.
See the following link for comparative appreciation rates:
www.census.gov/hhes/www/housing/census/historic/values.html
We also encourage you to go out and read the book Equity Happens (www.EquityHappens.com.) The basic premise of this book is yes, over time equity does happen, often times very, very slowly. But if you hold onto the real estate long enough, most owners see an increase in prices over time.
4. The last benefit from owning rental property is achieved through the paying down of the principal balance on your mortgages. Again, the rent you receive from your tenants will go towards paying those mortgages. Most of that money goes towards interest the bank charges you, however, some will go towards paying down the debt you owe. Over time you will build equity through paying down the loans as well.
Investing in vacation rentals can bring significant returns and personal enjoyment. You have complete control (and use!) over your investment, unlike stocks or mutual funds. Owning vacation rental(s) will bring constant passive income, which will allow you to retire, pay for college, increase savings or supplement your income. Investing in vacation rentals will minimize concerns about your current income or capital running out if your outgrow them. If you follow a conservative, long-term approach to investing, you will have more money coming in from rentals than from your day job sooner than you think!
There are four primary benefits to investing in real estate:
1. The first of these is cash flow. What is cash flow exactly? Well, to put it in simplest terms, cash flow is what money you have left over after the mortgages, the taxes, and the insurance have been paid. Again, the tenant pays you rent, and that money pays off these items. Whatever is left over goes into your pocket……that is cash flow.
2. Though many people buy rental property for cash flow, the real benefits that can build your net worth lie elsewhere. The second main benefit from buying rental property is the tax shelter that it creates for you. What does this mean exactly? Well, each time you buy a residential rental property, the IRS allows you to depreciate that property over 27.5 years. In other words, you can take this depreciation expense against your active income from your job. Let’s use a quick example:
Say you buy a $400,000 rental property. Again, the IRS lets you depreciate the building, not the land. Normally, 85% of the purchase price is used to determine the building, the physical house’s value. In this example, the IRS lets you depreciate $340,000 (the property) over 27.5 years. This is equal to $12,362 per year you can take a depreciation expense against your active income. In other words, say you make $80,000 in income from your job. Now, take $80,000 minus $12,362, which gives you $67,638. Now this is the income that you pay income tax on, $67,638, not $80,000 (which you actually made.)
You can see how by buying this one property, you have reduced your taxable income significantly. As you can guess, if you buy two houses, this number doubles, three, triples, etc. A real estate investor can usually take up to a max of $25,000 in depreciation expense each year. For those who qualify as a “real estate professional” through the IRS definition, this can be an unlimited number. Please be sure to talk with your CPA to find out how the numbers will play out in your personal situation.
It is important to remember however that the above examples are tax deferrals. If you sell the property, you do have to recapture this tax. However, many real estate investors use a 1031 exchange to continue to defer this tax.
3. The third main benefit from owning rental property is appreciation. As we know, not all debt is bad debt. In fact, many say that real estate debt is the best type of debt to have, for it is potentially appreciating debt. Again, your home may not appreciate at 10%, or even 5% every year, but at the very least, it should go up over time. This is the area that most real estate investors build their long-term wealth. Buy the properties, and then hold them.
Time for another quick example: say you buy a rental home totaling $400,000. Now let’s say that home appreciates 2% a year over 10 years. You now have a home that is worth $488,561. You now have $88,561 in equity by simply buying a house and holding onto it. Remember however, equity is not cash in your pocket. It is a number on your balance sheet. If you wanted to sell the investment property, you would have selling expenses of course which would reduce the above numbers.
See the following link for comparative appreciation rates:
www.census.gov/hhes/www/housing/census/historic/values.html
We also encourage you to go out and read the book Equity Happens (www.EquityHappens.com.) The basic premise of this book is yes, over time equity does happen, often times very, very slowly. But if you hold onto the real estate long enough, most owners see an increase in prices over time.
4. The last benefit from owning rental property is achieved through the paying down of the principal balance on your mortgages. Again, the rent you receive from your tenants will go towards paying those mortgages. Most of that money goes towards interest the bank charges you, however, some will go towards paying down the debt you owe. Over time you will build equity through paying down the loans as well.
Please contact me for turn-key investment and management services of positive cash-flow properties at the shore!
Fabian E. Kulynych, P.E.
609-575-4335
fabiankul@gmail.com
Fabian E. Kulynych, P.E.
609-575-4335
fabiankul@gmail.com