Owning a Rental Property
Purchasing a rental property is one option available to those wanting to invest in real estate. A rental property is a house, condo, or multifamily dwelling purchased to rent out the individual units. A lot of real estate investments are focused on growth, meaning that the return on your investment is based on the increased value of the property at the time you sell. With a rental property, most of your return will likely come from monthly rental income making it a long-term investment.
How to Do It
Investing in real estate requires a significant amount of capital upfront. Even if you have the cash available to make the purchase taking a mortgage might be a good strategy because the interest is tax-deductible. Choosing the right location can be a daunting task. It is important to consider the following:
- Number and size of units
- Fair market rents in the area
- Proximity to schools, shopping, public transportation
- Crime levels
- Property taxes in the area
- Costs of insurance
If you don’t have the time to manage the property yourself, you will have to hire someone. A professional manager will allow you to dedicate less time to your property but also gives you less control over the day-to-day operations. Beyond the general upkeep, a property manager must keep up the books, place ads to fill rental units, and interview prospective clients.
You should think about owning a rental property like running a business. The rent collected on a rental property is your revenue and will be subject to income tax, but the available write-offs are extensive. Mortgage interest, property taxes, insurance, advertising, maintenance, property depreciation, and other expenses are typically tax-deductible. The cost of a property manager and a tax accountant can also be deducted. You should be aware that the IRS views repairs and improvements differently. Repairs are considered an expense as they do not increase the overall value of the property. However, improvements that add value and prolong their useful life are considered capital investments and can only be recovered through depreciation over time.
Because a rental property is a capital asset, you may be required to pay capital gains when it is sold. If you sell the property for more than you paid, you have realized a capital gain. If this gain cannot be offset by capital losses, you will have to pay capital gains tax on this amount.
The Benefits of Owning a Rental Property
Real estate is a great way to diversify your portfolio. A rental property can increase your monthly cash flow and since it is considered a business property there are several tax deductions that can be used to offset your rental income. Not only do you get monthly income there is appreciation potential if you sell the property for more than you purchased it for. Rental properties also provide a certain amount of flexibility for the investor. There are a wide variety of property types and locations allowing you to choose what works best for you. You can start small with a single-family home or duplex, or you can purchase an apartment building.
The Risks of Owning a Rental Property
Real estate investments may not be appropriate for all investors. Not only do you have to find a good property in an up-and-coming neighborhood, but you also need to keep your property in top condition to find quality tenants. If you have units available for long periods of time you could be losing a lot in potential revenue. Tenants could run into financial difficulties and become delinquent with their rent payments, or not pay them at all. Economic changes in the area could affect your occupancy rates and property values. There could be changes in tax laws that reduce or eliminate the favorable tax treatment of rental properties. Real estate is also not a very liquid asset, making it difficult to turn your property into cash quickly should the need ever arise.
Boelman Shaw specializes in tax-efficient investing because every financial decision has tax implications. Our financial advisors and our Certified Public Accountants (CPAs) coordinate their efforts to ensure that your investment strategy does not cost you more in taxes. A lot of advisors can grow your investments and keep up with the market, but if their strategies do not consider those tax implications, you could be losing money in both the short and long term.
Tax and accounting services provided through Boelman Shaw & Company, LLC. Advisory services provided through BSC Capital Partners, LLC a state of Iowa registered investment advisor.