What is Investment Property?
Investment property is real estate property that has been purchased with the intention of earning a return on the investment, either through rental income, the future resale of the property or both. An investment property can be a long-term endeavor or an intended short-term investment such as in the case of flipping, where real estate is bought, remodeled or renovated, and sold at a profit.
Breaking Down Investment Property
The way in which an investment property is used has a significant impact on its value. Investors sometimes conduct studies to determine the best, and most profitable, use of a property. This is often referred to as the property's highest and best use. For example, if an investment property is zoned for both commercial and residential use, the investor weighs the pros and cons of both until he has ascertained which has the potential for the highest rate of return and then utilizes the property in that manner.
Difference Between Financing a Home and Investment Property
While borrowers securing a loan for a primary residence have access to an array of financing options, including FHA loans, VA loans and conventional loans from a variety of banks, in most cases it is more challenging to procure financing for an investment property than for a primary residence.
In particular, insurers do not provide mortgage insurance to investment properties, and as a result, borrowers need to have at least 20% down to secure bank financing for investment properties. Additionally, to approve borrowers for a mortgage on an investment property, banks insist on good credit scores and relatively low loan-to-value ratios. Some lenders also require the borrower to have ample savings to cover six months' worth of expenses on the investment property.
Reporting Earnings from Investment Properties
If an investor collects rent from an investment property, the Internal Revenue Service (IRS) requires him to report the rent as income, but the agency also allows him to subtract relevant expenses from this amount. For example, if a landlord collects $100,000 in rent over the course of a year but pays $20,000 in repairs, lawn maintenance, and related expenses, he reports the difference of $80,000 as self-employment income.
If an individual sells an investment property for more than he purchased the property, he has a capital gain and must report these earnings to the IRS. As of 2017, capital gains on assets that are held for at least one year are considered long-term gains and taxed at 15 percent, except for those who are married and have taxable income exceeding $450,000 or single and have income exceeding $400,000, in which cases the rate is 20 percent. In contrast, if a taxpayer sells his primary residence, he only has to report capital gains in excess of $250,000 if he files individually and $500,000 if he is married and filing jointly. The capital gain on an investment property is its selling price minus its purchase price minus any major improvements.
To illustrate, imagine an investor buys a property for $100,000 and spends $20,000 installing new plumbing. A few years later, he sells the property for $200,000. After subtracting his initial investment and capital repairs, his gain is $80,000.
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Please read the following general information.
Because real estate is such an inefficient market, it's possible to find awesome bargains on properties with a very high return on investment. If you can manage the property yourself, you can collect more income. If you purchase the right property at the right price and on the right terms, a rental property can produce significantly more income than traditional passive investments.
How Much Money Do You Need?
If you plan to finance your purchase with a mortgage, you'll need to take action before you retire. Mortgage lending guidelines typically require applicants to be employed and have at least two years of steady employment history in the same occupation.
Lenders also require a substantial down payment, typically 30% or more, if the buyer won't be occupying the property. If you don't have the cash to make such a large down payment, consider using your IRA funds. All equity growth and income from rental receipts will grow inside your IRA tax-deferred. Purchasing the property with funds inside a Roth IRA, on which you've already paid taxes, means all your earnings and equity can grow tax-free.
After you've figured out how you're going to buy the property, you need to think about how you're going to cover ongoing expenses. Owning residential income property is like owning a principal residence in that there are variable expenses outside the mortgage. There are maintenance costs for minor items (like leaky faucets) and major items (like a new roof).
What Will You Earn?
Expenses include the mortgage; taxes; insurance; maintenance; a 10% property management fee; and a 10% vacancy-rate allowance.
If you invest $100,000 in the property, you want to earn a net income of $8,000 (8%) a year. The reasoning behind the 8% is that it compensates you for the risk and lack of liquidity of your investment. If you or your spouse can work on the property by doing repairs and maintenance and/or managing the property, your costs will decline and your income will ultimately increase.
Investment property owners could run into a number of problems, including renters who fail to pay; excessive maintenance costs; and difficulty finding tenants. Working with a reputable real estate agent with references to find your investment property is also important. They should also be aware that homestead exemptions don't apply to investment properties, which can mean higher property tax bills. Finally, selecting the right tenant is key. Running a thorough screening is crucial.