Today I will wrap up the 8 reasons to invest in real estate. As a quick review, I shared in recent blogs that real estate is a great business to invest in because it has built in demand, great leverage, you have direct control over your investment, it provides cash flow, near perfect arbitrage, and it is the only investment that you can insure! Today I want to share with you the last 2 reasons I like to invest in real estate—equity build up and tax benefits.
Equity Build Up (AKA Equity Buy Down)
One reason that I like real estate is equity build up. Also known as equity buy down, this is when you pay down the principal. Equity build up works like a forced savings account. It adds up tremendously. Remember there are two primary parts to a mortgage payment—principal and interest. Every time you make a payment, a portion is being put towards principal and the remainder is put towards interest. At the beginning, most of the payment is going towards interest but from the second payment on, the ever increasing amount goes to principal. It is basically forcing you to save!
Understanding the tax benefits of real estate can be transforming. The kind of income that comes from real estate is taxed at a much lower rate than earned income. And real estate investment income often does not need to be taxed.
Capital Gains Income is income made from selling real estate for a profit after you have owned it for 12 months or more. If you own if for LESS than 12 months, it will be taxed! So, be careful.
Sell of Property and 1031 Exchange is when you have owned a property for more than 12 months, you can utilize a 1031 exchange. This shelters you from paying any taxes on the gains. Technically the taxes are “deferred”, but for your lifetime no taxes are due. At the end of your investing life, you can roll the 1031 into a Charitable Remainder Trust and your heirs can receive benefits from those assets.
Depreciation is an artificial loss that the IRS allows and it costs you no money out of your cash flow. For example, let’s say you purchased a home for $90,000 and you spent $10,000 to fix it up. You now have $100,000 invested in the property. For tax purposes, your “basis” in the property is what you paid for the property plus the rehab costs MINUS the value of the land that it sits on. The IRS lets you deduct 1/27th of the $100,000 as depreciation. So, that is $3,704 that you get to deduct directly from your cash flow!
Other Expenses are all tax deductible. Loan interest, real estate taxes and other costs to manage the investment property are expenses that are tax deductible. Most of the time, adding depreciation to these other expenses will cover any net cash flows from the property for tax purposes, even though you have a positive cash flow.
Armstrong Williams is a well-known commentator and entrepreneur. He says this about real estate: “Now, one thing I tell everyone is learn about real estate. Repeat after me: real estate provides the highest returns, the greatest values and the least risk.” His words echo exactly what I have been sharing with you.
Are you ready to invest in real estate, now?
For more information on investing in real estate, check out the Real Estate workshop coming up in September in Colorado!