BLOGBlog posted On May 06, 2021
Investment properties are primarily used to generate additional income. With the money generated from rental payments you can profit every year in the form of passive income. Plus, you could qualify for significant tax benefits, increase your wealth, and diversify your investment portfolio.
Passive income
One of the biggest perks of a well-managed investment property is the additional income it can provide. Not only are you getting renters to help pay off your mortgage, but you’re also generating extra cash flow. As you build up your equity over time, your cash flow will likely gain strength – providing even more profits. “You can use a bank or lender’s money to purchase an asset and then rent it out at a price that allows for you to have cash flow on a monthly basis,” says Luke Smith, owner of a real estate investment company in Kentucky.
Tax benefits
Because investment properties are seen as an additional source of income, its rental profits are taxable. Owning an investment property can give you two main tax benefits: deduction and depreciation. Deduction helps lower your overall taxable income, which in turn lowers your tax liability and the amount of money you pay on your annual federal tax returns. You can deduct any investment property costs (property taxes, mortgage interest, property repairs etc.) from its rental profits. For example, if your investment property generates $11,000 in rental income per year but you spend $5,000 on maintenance, your taxable income would be $6,000. This would make your tax payments significantly smaller. If your federal income tax bracket is 22%, then your annual federal income tax on this property would be $1,320 instead of $2,420. Plus, investment property income is seen as passive income – meaning it is not subject to Social Security tax or Medicare tax.
Depreciation is the process of deducting your investment property purchase price from your taxes over time. Oftentimes, depreciation is used in a business setting. If you bought a piece of machinery for your business that was set to last 10 years, then you would be able to deduct one-tenth of its total cost every year. For residential investment properties, the IRS has set a standard deprecation period of 27.5 years. So, if you purchased an investment home for $200,000 dollars, your annual tax deprecation deduction would be $7,272 (200,000 divided by 27.5). The idea is that you would have the entire purchase price of the home deducted from your taxes after 27.5 years.
Diversified portfolio
By investing in real estate, you diversify your financial portfolio and decrease financial risk. Having a variety of investments (stocks, real estate, bonds) can protect your wealth and boost your earnings. If all of your investments were in stocks, and the market crashed, you would be in a difficult financial position. But if you had money invested in other markets as well, like real estate, then you would still have another source of cash flow despite the stock crash. Additionally, investing in real estate gives you a lot of opportunities and “provides so many different ways to make money,” says Christian Cruz, J.D. owner of WeOfferCashforProperties.com. “For example, you can flip houses, develop land, […] change property use, and so on.”
Purchasing an investment property is a great way to build wealth. Though not all mortgage programs offer investment property financing, there are still several other investment home loan options. One way to start is through a cash-out refinance. If you have enough equity built up in your primary residence home, you could exchange some equity for cash in order to finance the down payment for your investment home.
As always, make sure you consult a financial professional before committing to a real estate investment. If you would like help finding a financial advisor or REALTOR®, let us know. To talk more about investment property benefits or determine your financing options, contact us today.
Sources: Motley Fool, Time
