Investment real estate can be an excellent option for growing your wealth. It can offer you long-term income, it can increase in value over time, and it can be a natural fit for your overall wealth-building strategy. But it is absolutely not a one-size-fits-all investment option.
So, how do you know if investment real estate is going to give you the return that you’re hoping for? Start learning! Educate yourself on what you would actually be getting yourself into.
Think of real estate investment as having four main buckets of focus:
If you’ve ever purchased a house, you’re already familiar with this process. If you buy real estate, you’ll have transaction fees to deal with. Those include a 20% down payment, closing costs (usually around 3% of your purchase price) and emergency savings to cover other issues or needs that might come up.
If you want to make money in real estate, you’ll have to have a healthy amount of liquidity to cover all the fees and costs that go into purchasing property.
Investment Real Estate Maintenance
Deciding how to maintain your property is a major decision for any real estate investor. You might choose to manage your property on your own, or with the help of a manager. But if you’re managing multiple properties, you might choose to work with a property management company.
Working with a management company is pricey, but if your business needs it, it could also be a huge asset.
A property management company:
- Manages tenants and prospects
- Collects rent
- Handles marketing
- Takes care of repairs and maintenance needs
- Brings industry experience and expertise
- Is an independent contractor, not an employee
Because working with a management company is a hefty investment, make sure it’s right for you. You might consider a property management company if you’re managing several properties, you don’t live near your property, you have limited time, you don’t want to be an employer or you don’t want to be involved with hands-on management.
One question that’s going to come up in investment real estate is whether or not to put your property in an LLC (limited liability company.) The answer to that question is going to depend on your situation and goals. It’s not right for everyone, so weigh the pros and cons:
Benefits of an LLC for rental property:
- Tax advantages – An LLC gives you several tax benefits. These include partnership taxation, double taxation avoidance, pass-through taxation and S-Corp taxation to reduce self-employment and other taxes. You wouldn’t necessarily receive all of those perks, but you could be eligible for some depending on your situation.
- Asset protection – When you’re dealing with tenants, you want to make sure you’re protected in case someone gets injured on your property. An LLC gives you that protection.
- Sounding professional – Some people seriously just want the “LLC” in their title to sound legitimate.
- Cost – The fee for becoming an LLC is going to vary by state, but it can be a pretty hefty annual fee. Really consider if you can (and should) afford the cost of being an LLC.
- Financing – Lenders can be hesitant about lending to LLCs. If you’re interested in becoming an LLC, be aware you may not be able to receive financing from lenders.
- Foggy Asset Protection – Asset protection is one of the main reason people want to become an LLC, but there are areas that aren’t totally clear. An LLC doesn’t always protect you from lawsuits, so make sure you know where the weaknesses are.
To LLC or not to LLC? There is no clear cut answer, so weigh your options carefully before you make a decision.
There are some tax ramifications that come up with investment real estate properties. These include:
- Capital Gains – With investment real estate, you need to pay taxes on profits (gains) that you earn. On the other hand, money you lose can be deducted. The total amount in your investment property is called your basis, and this changes over time. Any reductions in your new basis from your starting investment amount can increase your tax liability when you sell the property because it increases your gain. On the flip side, increases in basis reduce your gain and your tax liability.
- Depreciation Recapture – Depreciation recapture is part of the gain received from a property sale, which needs to be reported as income. So depreciation recapture is assessed when the sales price of a property is higher than the tax basis and the owner had taken a depreciation deduction on the property or any associated equipment (like an air conditioner). Part of the gain that is related to the depreciation that has been previously claimed may need to be “recaptured” when it’s reported as income.
- Like-Kind Property – Business or investment assets that are the same kind may be able to be exchanged tax-free. In the U.S., this like-kind exchange is possible through a Section 1031 exchange. This section allows investors to put off capital gains taxes on like-kind properties for business or investment purposes. The tax payment is deferred until the property is sold without reinvestment. But don’t consider Section 1031 an out for your investment property; it only applies if you’re selling one property and gaining another.
So is it worthwhile for you to invest in real estate? That answer is going to vary hugely for everyone, but if you consider each of the above points, you’ll be better equipped to make that call.
About Your Richest Life
At Your Richest Life, Katie Brewer, CFP®, believes everyone should have access to financial resources and coaching. For more information on the services offered, contact Katie today.