Why Invest?

Are you paying too much in income taxes?

Are you concerned about throwing away your money on rent?

Are you looking for a sound investment with appreciation historically proven to be above average?

Would you like to contribute to your long-term wealth?

Generate income, while enjoying property appreciation?

Control thousands of dollars of properties with little or no money down?

Real estate remains one of the most tax-efficient, low-risk, sound investment opportunities available. I believe if you plan your investments right, understand your goals, your risks and rewards, real estate is one of the most powerful investment tools around. Many people hesitate to buy, and by doing so they get further behind. Real estate offers substantial benefits to an investor including:

In the United States, real estate has proven itself as the most secure form of security for a loan. Lenders are convinced that these loans pose the lowest risk of loss to the bank and as a result, real estate loans usually get the lowest interest rates, the longest repayment term, and the lowest down payment requirements of any other bank loan. You can purchase real estate with little or no money down. For example if you put 10% down, investing only $100,000 will usually enable you to take control of a $1,000,000 property. With real estate, the ability to leverage your invested cash is greater than most any other kind of investment. Many people do not take the first step toward home ownership because they are afraid they may not qualify or can't afford to invest. With a variety of loan programs available today,  it is wise to explore your options, you may be better off than you think.

Historically, properties in California have enjoyed above average appreciation. Growth in house prices can never be guaranteed but the demand for homes is still outstripping the supply. As long as this trend continues, residential investment properties will most likely have substantial capital appreciation.

Residential investment properties have the distinct advantage of income production. The income derived from rents can be applied toward monthly expenses. Over time, as property rents increase, the house will yield a positive cash flow.

If you are lucky enough to earn above average income, you are probably paying too much in income taxes. Real Estate provides one of the few remaining tax savings tools. If you own your own home, you can deduct all the yearly interest, as well as, real estate taxes from your income. This will greatly reduce your taxable income, and therefore your taxes. For further tax savings, you can purchase income properties.  Investing in income properties can provide you with tremendous tax savings. While your property appreciates, you may deduct depreciation and all the expenses associated with owning the property from your income. The following provides a quick guideline to help you estimate your tax savings on your income properties. For a detailed analysis of your specific tax situation please consult your tax advisor.       

1. Deducting Investment Losses - You can deduct all reasonable expenses associated with owning the property including home owners’ association fees, mortgage interest, insurance, utilities, maintenance, supplies, and property taxes.

Maximum Deductions:

a. If you are not a qualified real estate professional: For tax purposes real estate investments are called passive activity. Unless you are a real estate professional as explained below, to qualify for passive activity loss deduction you must own at least 10 percent of the investment property and you must materially participate in property management decisions. You are limited to a maximum deduction of $25,000 annual passive activity against your taxable income. This deduction is gradually phased out if your annual adjusted gross income exceeds $100,000. At $150,000 adjusted gross income the allowable deduction becomes zero; however, any undedicated real estate investment tax loss is suspended for future use. For example, when the property is sold, this suspended tax loss can be subtracted from the capital gain to lower your taxable profit. Unused tax losses from investment properties cannot be carried back to prior tax years to claim a refund. Material participation is required for investor tax breaks.

b. If you are a qualified real estate professional: Qualified real estate professionals such as brokers, agents, property managers, builders, and contractors are eligible for virtually unlimited income tax deductions from their investment property deductions against ordinary income. To qualify, you need to spend at least 750 hours per year or 50% of your working hours, involved in real estate activities.

2. Deducting Depreciation - You can depreciate the building and the improvements. You cannot depreciate the land. The depreciable basis is normally the purchase price minus the value of the land. Residential real estate that is held for rent and income-production is depreciated over 27.5 years. Such properties include apartment buildings, condominium units, cooperative units, duplexes, and houses rented as residences for tenants. Residential investment properties provide for more tax savings than commercial real estate. To qualify for residential category, the building must receive at least 80% of its gross rental income from the residential dwelling units.

Calculating Depreciation - To calculate the depreciation deduction for investment property purchased and placed into service after Jan 1, 1987; MARCS (Modified Accelerated Tax Recovery System) table is used. For example:

Property value= $1,000,000      Land value = $200,000 Date of purchase = May 2001

1. Determine the depreciable basis (normally purchase price – value of the land):

      $1,000, 000-$200,000=$800,000

2. Multiply the basis by the factor obtained from the MARCS table using purchase date factor (month of May).

First year deduction: 2.273% x $800,000 = $18,184

Second year deduction: 3.636%X $800,000 = $29,088

Third year deduction: 3.637% X $800,000 = $29,088

Recapture of depreciation benefits - The maximum capital gains tax rate was reduced to 15 percent in 2003 for assets owned more than 12 months. (If held for less than 12 months gains are taxed as ordinary income. However, the IRS requires that you "recapture" the tax saving from your income tax at a special 25 percent depreciation "recapture" tax rate when the property is sold. Example below further illustrates this point:

·         Assume you bough an investment property for $200,000 and deducted $50,000 of depreciation during your ownership years. In this case: Your adjusted cost basis or book value = $200,000 - $50,000 = $150,000

·         If you sold the property for $350,000, Your capital gain = $350,000 – $150,000 = $200,000

·         Out of your capital gain, the $50,000 depreciation will be recaptured and taxed at the 25% federal tax rate

·         The remainder $150,000 of the capital gain will be taxed at the new 15% maximum tax rate.

If you make a tax-deferred exchange with another investment property, you can avoid paying federal recapture taxes on the depreciation you had deducted.

Written by Farrah Anderson