If you are a wealthy individual or earn a high income, you should consider real estate for these four reasons: tax benefits, passive income, long-term asset appreciation, and leverage. Real estate has been at the forefront of everyone’s radar right now since the last crash of 2008-2010. But has anyone ever explained why it is such an investment vehicle for wealth creation and income protection?
Nope? Well, as an investor and lawyer, I regularly advise clients on real estate matters and help them with their investments. In this article, I’ll tell you why real estate should be part of your investment portfolio and why you should get started now as the market cools.
REAL ESTATE AND TAXES
Real estate is one of the few asset classes with multiple tax advantages that are underestimated by financial advisors. Why? Financial advisors may not take a commission from them, or you may not actually need a financial advisor to get into real estate. Not to diminish the role of your adviser but you do need a financial adviser to understand these real estate tax benefits.
- Real estate is depreciable. Yes, you can depreciate residential real estate over 27.5 years and commercial real estate 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 take a $500,000 residential property and depreciate it over 27.5 year. This means that you can deduct $18,181.81 each year in depreciation.
- Real estate capital gains can be deferred. Under Section 1031 of the tax code, if you hold property for the required holding period, which is not defined in the tax code, you can sell that property through a like-kind exchange using a intermediary to hold funds while you identify new property or properties within 45 days and close identified targets within 180 days. This allows you to defer capital gains taxation and avoid recapture of depreciation while purchasing larger and hopefully more profitable real estate assets. Thus, this tax mechanism allows the investor to take advantage of their profits and exploit them in more assets, thus developing the real estate portfolio in a tax-efficient manner.
- Cost segregation. Depreciation of real estate can be accelerated by using cost segregation studies to divide assets into its different parts that fall under separate categories to allow 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 instead of using the 27.5 or 39 year life of the entire asset. A net result of a cost segregation study is to accelerate depreciation to allow more Section 179 depreciation to be taken earlier in the life of the asset.
While other tax nuances can be discussed, it is the tax advantages that high net worth individuals should look into. Additionally, by working with an experienced attorney who understands the individual’s needs and goals, tax losses can be carried forward for years to come.
REAL ESTATE AND PASSIVE INCOME
Whether it’s long-term residential real estate, commercial storage units, short-term residential real estate, or apartment syndication deals, real estate allows the owner and investor to play a passive role in the management of their property by using property managers.
Using property managers gives the investor peace of mind that their investment is in good hands for day-to-day matters such as maintenance, and that their tenants are safe knowing they have someone. who to turn to if the need arises. Additionally, for the cost of monthly management fees, ranging from 3-40% of monthly gross rents, higher percentages are generally found with short-term rental management and lower fees with long-term residential property management, there’s no need to worry about late-night phone calls about clogged toilets.
Property managers will also ensure that the yard is maintained, utilities are paid for, tenants are of the desired caliber, and all marketing efforts to rent properties are undertaken to ensure maximum rental potential. At the end of each month, an income statement is generated by the property manager and a check or direct deposit is made to the investor’s designated bank account. A true passive investment.
ASSET APPRECIATION AND LEVERAGE
While your tenant pays the rent each month or in the case of short-term rentals, multiple tenants, the note held by the investor is refunded. Historically, real estate goes up in value, so the asset goes up in value. As the value of the asset increases and the debt is repaid, the investor benefits from the growth in equity. It is with this growth in equity that the value of real estate cannot be overestimated.
By tapping into equity growth through refinancing or an equity line of credit, the investor can leverage this internal equity to purchase additional real estate. Additional real estate purchases allow the investor to generate more cash flow, and more tax advantages. Regardless of the type of asset, short term, long term or commercial real estate, the benefits to the investor are tangible in the form of tax deductions while maintaining positive monthly cash receipts.
As many investors ponder the current real estate market, it would be worthwhile for their long-term goals to consider real estate as an addition to their financial portfolio. As iconic long-term investor Warren Buffet said, “Be fearful when others are greedy, and greedy when others are fearful.”
Written by Brian T. Boyd, Esq.
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