Real estate is one of the best investments you can make to build wealth. In this article, we will share several real estate strategies for beginner investors that professional firms like Nelson Partners utilize.
Before looking at any particular strategy, it is important to reiterate the difference between an investor and a speculator. An investor seeks to buy a property at a discount price and holds on to that property, allowing the real estate to appreciate over time. The investor makes their return on capital gains and not from cash flow. The speculator is looking for a quick return, expecting that they will be able to flip the property quickly or hold onto it until market appreciation pays them handsomely for doing nothing other than owning the property and taking advantage of other people’s ignorance.
Speculation, though not illegal, is frowned upon by industry professionals and will negatively impact your ability to conduct business with other real estate investors or lenders.
Investing in Real Estate for Cash Flow
As you are looking to purchase rental properties, one of your primary objectives should be to secure properties that generate positive cash flow. Cash flow is defined as the monthly cash that is available after all expenses and carrying costs (interest and principal payments on mortgages, property taxes, insurance, etc.) have been paid by the owner.
Cash Flow Benefit of Rental Property
Real estate gives you an advantage over many other investments because it provides you with a tax deduction for many of the expenses of owning that property, which effectively reduces your actual cash outlay.
Property taxes are deductible in the year paid
If you buy a property with a mortgage, interest is also deductible in the year it is paid. However, if you pay off the loan early and there are extra months of interest left over at 12% per annum or higher (which is most mortgages), it can be carried forward to reduce your taxes in future years when you have less income.
The biggest advantage of rental properties, however, comes in depreciation deductions. If you purchase an asset like stocks or bonds, they do not give you tax benefits until they are sold because there is no deduction for “depreciation” since these assets don’t “wear out.”
Real estate depreciation deductions are given annually based on useful life of the building.
The depreciation calculation is pretty complicated, but generally, the shorter the asset’s useful life, the larger the deduction you can claim. You may also be able to claim a portion of real estate taxes and insurance as an expense in future years when your cash flow goes negative due to vacancy or repairs.
Income from Rental Property
Rental income from a real estate property is a dependable income source that is usually highly taxable, especially if you do not itemize deductions and choose the standard deduction. Those who itemize their deductions will reduce their taxable income by the amount of their rental expenses (property taxes, insurance, repairs, and maintenance) and depreciation (a non-cash deduction).
You must include rent received as income unless the rental is considered a “business” loss where you can offset this income with your other business losses. For example, if you are an agent, you may be able to claim these expenses as part of your self-employment taxes.
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