If you have thought about dipping your toes into the ocean of investment real estate but have yet to take the plunge, let me simplify your decision with why this is one of the best ways to grow your net worth while possibly reducing your tax bill.
1. Cash Flow – For a new investor this is an absolute no brainer and most people identify this benefit right away.
Income – Expenses – Debt Load = Cash Flow
Income is your gross rent. Expenses can include things like maintenance, property management, cleaning, etc. Debt is the mortgage payment you make to your bank (if applicable). Cash flow is the profit you assume and you can spend it or reinvest it. If you want to scale your investment real estate portfolio, cash flow can help establish a savings account for your next property down payment.
2. Property Appreciation – Year over year you can expect an average and conservative appreciation rate around 2%. This is based on the value of the dollar and target rate set by The Federal Reserve. In years like 2020-2021 we experienced appreciation at a rate of over 20% in many markets! Although this is not typical, there can be years where millionaires are created seemingly overnight.
3. Increased Equity – Equity is the difference between the value of the property and what you owe on the loan. So if you have a property worth $400K and you owe $100K on the loan, you have equity in this property worth $300K.
If you don’t plan to sell your home, the built up appreciation and equity is useless right? Wrong! You can borrow against the increased equity you acquire over time (through appreciation and paying down your debt) and you can leverage this money tax free! Since a cash out refinance is considered debt, you are not paying any taxes on it and this cash can be leveraged to acquire your next property.
4. Tax Benefits – So this is where things get a little complicated, but the gist is this: your real estate purchases can help offset how much you owe the government each year in taxes. The US government wants us to purchase real estate so they incentivize us with tax benefits like depreciation. This little trick allows you to write off a certain amount over a certain number of years. In some cases, if you’re deemed a “Real Estate Professional” you can deduct a large chunk immediately through “Cost Segregation”. The IRS has many rules around this topic, so please consult your tax advisor on the specifics here.
A household that makes 500K per year in income could theoretically buy one property and write off $150K of depreciation in year one (through a cost segregation study), which would save them about $50K in taxes. *Depends on their tax bracket, filing status, and ability to be a Real Estate Professional.
The interest you pay on your debt payments is also tax deductible so this is another reason why leveraging someone else’s money DOES make sense.
5. Use of your own property – When you put money into the market, you can’t live in that money, it’s not tangible. But real estate provides a unique way to grow your money and still enjoy an actual tangible product! As the owner of a beach vacation home you can save yourself thousands of dollars per year in vacation expenses. As the owner of a commercial building you can save yourself from paying rent for your own business use, storage space, etc.
The benefits I have laid out here are not exhaustive but I hope this helps give you a better picture of why so many people invest in real estate. Especially for business owners that need to offset income through other businesses, real estate can be a wonderful way to lower your tax burden and diversify income.
If you are interested in discussing any of these benefits in more detail, reach out and let’s talk.