 | |
provided by:
For Dummies is a registered trademark of Wiley Publishing, Inc. in the United States and other countries. Used here by license.Although you can easily get started with traditional investments such as stocks and mutual funds with a few hundred or thousand dollars, the vast majority of quality real estate investments require far greater investments — usually on the order of tens of thousands of dollars. If you’re one of the many people who don’t have that kind of money burning a hole in your pocket, don’t despair. We present you with lower cost real estate investment options. Among the simplest low cost real estate investment options are real estate investment trusts (REITs). You can buy these as exchange traded stocks or you can invest in a portfolio of REITs through a REIT mutual fund.
Diversification valueAn advantage of holding investment real estate is that its value doesn’t necessarily move in tandem with other investments, such as stocks or smallbusiness investments that you hold. You may recall, for example, the massive stock market decline in the early 2000s. In most communities around America, real estate values were either steady or actually rising during this horrendous period for stock prices. However, real estate prices and stock prices, for example, can move down together in value. Sluggish business conditions and lower corporate profits can depress stock and real estate prices.
Ability to add valueAlthough you may not know much about investing in the stock market, you might have some good ideas about how to improve a property and make it more valuable. You can fix up a property or develop it further and raise the rental income accordingly. Perhaps through legwork, persistence, and good negotiating skills, you can purchase a property below its fair market value. Relative to investing in the stock market, persistent and savvy real estate investors can more easily buy property in the private real estate market at below fair market value. You can do the same in the stock market, but the scores of professional, full-time money managers who analyze the public market for stocks make finding bargains more difficult.
Tax advantagesReal estate investment offers numerous tax advantages. In this section, we compare and contrast investment property tax issues with those of other investments.
Deductible expenses (including depreciation)
Owning a property has much in common with owning your own small business. Every year, you account for your income and expenses on a tax return. For now, we’d like to remind you to keep good records of your expenses in purchasing and operating rental real estate. One expense that you get to deduct for rental real estate on your tax return — depreciation — doesn’t actually involve spending or outlaying money. Depreciation is an allowable tax deduction for buildings, because structures wear out over time. Under current tax laws, residential real estate is depreciated over 271⁄2 years (commercial buildings are depreciated now over 39 years).
Tax-free rollovers of rental property profitsWhen you sell a stock or mutual fund investment that you hold outside a retirement account, you must pay tax on your profits. By contrast, you can avoid paying tax on your profit when you sell a rental property if you roll over your gain into another like-kind investment real estate property. The rules for properly making one of these 1031 exchanges are complex and usually involve third parties. We cover 1031 exchanges in Chapter 16. Make sure that you find an attorney and/or tax advisor who is an expert at these transactions to ensure that everything goes smoothly (and legally). If you don’t roll over your gain, you may owe significant taxes because of how the IRS defines your gain. For example, if you buy a property for $200,000 and sell it for $550,000, you not only owe tax on that difference, but you also owe tax on an additional amount, depending on the property’s depreciation. The amount of depreciation that you deducted on your tax returns reduces the original $200,000 purchase price, making the taxable difference that much larger. For example, if you deducted $125,000 for depreciation over the years that you owned the property, you owe tax on the difference between the sale price of $550,000 and $75,000 ($200,000 purchase price minus $125,000 depreciation).
Installment salesInstallment sales are a complex method that can be used to defer your tax bill when you sell an investment property at a profit and you don’t buy another rental property. With such a sale, you play the role of banker and provide financing to the buyer. In addition to collecting a competitive interest rate from the seller, you only have to pay capital gains tax as you receive proceeds over time from the sale.
Special tax credits for low-income housing and old buildingsIf you invest in and upgrade low-income housing or certified historic buildings, you can gain special tax credits. The credits represent a direct reduction in your tax bill from expenditures to rehabilitate and improve such properties. These tax credits exist to encourage investors to invest in and fix up old or run-down buildings that likely would continue to deteriorate otherwise. The IRS has strict rules governing what types of properties qualify. See IRS Form 3468 to discover more about these credits.
| |
provided by:
For Dummies is a registered trademark of Wiley Publishing, Inc. in the United States and other countries. Used here by license.