If you are a high net worth or high-income individual, you should consider real estate for the following four reasons: tax benefits, passive income, long-term asset appreciation, and leverage. Real estate is currently on everyone’s radar since the last crash in 2008-2010. But has anyone ever explained why it is an investment vehicle to build wealth and income?
number? Well, as an investor and attorney, I routinely advise clients on real estate issues and help them with their investments. In this article I will explain to you why real estate should be part of your investment portfolio and why you should enter now when the market is cold.
Real estate and taxes
Real estate is one of the few asset classes with multiple tax benefits that financial advisors don’t appreciate. why? Financial advisors may not charge them or you don’t actually need a financial advisor to get into real estate. Don’t underestimate the role of your advisor but you don’t need a financial advisor to understand these property tax benefits.
- Real estate is depreciable. Yes, you can depreciate residential property over 27.5 years and commercial property over 39 years. 26 USC Section 179 allows real estate to be depreciated over the life of the asset class, and in the case of real estate, you can have a $500,000 residential property and depreciate it over 27.5 years. This means that you can deduct $18181.81 each year in depreciation.
- Real estate capital gains can be deferred. Under Section 1031 of the Tax Code, if you own property for the required holding period, which is not specified in the tax code, you may sell that property via an exchange of a similar type using a broker to hold the money while you select new property or properties within 45 days and close those specified targets within 180 days. This allows you to defer capital gains taxes and recover depreciation while purchasing larger, and hopefully better, real estate assets with better cash flow. Thus, this tax mechanism allows the investor to reap his profits and benefit from them in more assets and thus grow the real estate portfolio in a tax efficient manner.
- cost separation. Depreciation of real property can be accelerated by using cost separation studies to break down the assets into their different parts that fall into separate categories to allow the individual components to be depreciated over 5,7 or 15 years. This allows the components of the property to be used in a tax efficient manner rather than using a class age of 27.5 or 39 years for the entire asset. The net result of the cost separation study is to speed up depreciation to allow for more Section 179 depreciation to be taken earlier in the life of the asset.
While more tax nuances can be discussed, these are the tax advantages that high net worth individuals should consider. Additionally, by working with a sophisticated attorney who understands an individual’s needs and goals, tax losses can be carried over to future years.
Real estate and passive income
Whether you use long-term residential properties, commercial storage units, short-term residential properties or condominium deals, real estate allows the owner and investor to take a passive role in managing their properties by utilizing property managers.
The use of property managers provides the investor with peace of mind that their investment is in good hands for day-to-day matters such as maintenance, and that their tenants are safe in the knowledge that they have someone to turn to in the event a need arises. Moreover, for the cost of monthly management fees, ranging from 3-40% of total monthly rents, there are usually higher rates with short term rental management and lower fees with long term residential property management, you don’t have to worry about late phone calls of the night about a clogged toilet.
Property managers will also ensure that the yard is maintained, utilities fees are paid, tenants are of the required caliber, and any rental property marketing efforts are made to ensure maximum rental potential. At the end of each month, a revenue statement is generated by the property manager, and a check or direct deposit is made available to the bank account designated by the investor. A real passive investment.
Asset estimation and leverage
While the tenant pays the rent every month or in the case of short-term rentals, or multiple tenants, the note is paid by the investor. Historically, the value of real estate appreciates and therefore the value of the assets increases. As the value of the asset increases and the debt is paid off, the investor receives the benefit of capital growth. With stock growth this real estate cannot be overvalued.
By taking advantage of equity growth through refinancing or an equity line of credit, an investor can take advantage of that internal equity to purchase additional real estate. Additional real estate purchases allow the investor to generate more cash flow and more tax benefits. Regardless of the type of asset, short-term or long-term real estate or commercial real estate, the benefits to the investor are tangible in the form of tax deductions while maintaining positive monthly cash receipts.
While many investors look at the current real estate market, it would be beneficial for their long-term goals to consider real estate as a supplement to their financial portfolio. As famous investor Warren Buffett said, “Be afraid when others are greedy and greedy when others are afraid.”
written by Brian T Boyd, Esq.
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