8 Things You’ll Love about Real Estate Investing: Part 4

Real estate investing is my personal favorite form of investing. As far as making money and protecting your investment goes, real estate investing is weighted with advantages. In fact, income in the form of rents puts approximately 30% more money in your pocket than income from your job! These advantages can really empower you as a real estate investor. Over the last three weeks I covered six reasons real estate investing is so awesome: demand, leverage, cash flow, control, arbitrage and equity build up. This week I’m covering the last two: tax benefits and insurance.

Here are the eight reasons real estate investing is so powerful:

1. Demand
2. Leverage
3. Cash Flow
4. Control
5. Arbitrage
6. Equity Build Up
7. Tax Benefits: Understanding the tax benefits of real estate can be financially transforming. The kind of income (passive or capital gains) that comes from real estate is taxed at a much lower rate than earned income (income from a job or short term investing). I know this sounds illegal or too good to be true, but the honest truth is that real estate investment income often does not need to be taxed. At all. For one thing: no social security tax has to be paid on passive income! It all depends on how you go about things. 
   • Capital Gains Income: This income is made from selling real estate for a profit after you have owned it for 12 months or more. Be careful now. As a real estate investor, note that when you sell property you’ve owned for less than 12 months it counts as earned income and is taxed a a higher rate!
     • Sell of Property and 1031 Exchange: This tax benefit is absolutely amazing.  If I sell a $100,000 property for $200,000 after I have owned it for more than 12 months I can utilize a 1031 exchange. This shelters me from paying any taxes on the capital gains of $100,000. Let me repeat: no taxes! Now technically the taxes are “deferred,” but for your lifetime no taxes are due. At the end of your investing life, you can role the 1031’s into a charitable remainder trust and your heirs can receive benefits from those assets. Another benefit of the 1031 is that it permits you as an investor to not have to “recapture” the depreciation advantages and pay capital gains on the amounts that were depreciated. More on that below:
   • Rental Income: Income made by receiving rent from tenants. This is true passive income.
     • Depreciation: Let’s say you purchased a single-family home as an investment property 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 ($90,000 + $10,000) minus the value of the land that is sits on. But just as an illustration, let’s say your real tax basis in the property is $100,000. Although it should be increasing in value, you get to depreciate this property every year at approximately 1/28 of that $100,000. That is $3,571 that you get to deduct directly from the rental income! Remember: this depreciation deduction is an artificial loss that the IRS allows and it actually costs you no money out of your cash flow.
     • Other Expenses: Loan interest, real estate taxes, and other costs to manage the investment property are all 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 (money you can use and spend).
8. Insurance: If the market falls flat in stocks, it’s difficult to get your investment back. But real estate is an investment that can be protected and insured. Real estate is one of a small number of investments that can actually be insured against loss. You can insure properties against hazards like fire and tornadoes. You can even protect yourself against lost rents if something happens to your investment property. You can get liability insurance. Liability insurance protects you or your entity against financial loss if someone is hurt on your property. Get this! You can even get equipment loss insurance. This insurance is one that I apply on all my rental properties. If an HVAC, hot water heater, dishwasher or other equipment failure occurs, then equipment loss insurance will repair or replace it for a small deductible. It’s wonderful.
   

These are the eight things I love about real estate. Stay tuned next Thursday for more real estate topics!

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