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Rental Property Depreciation For The Real Estate Beginner That Will Maximize Profits

Rental Property Depreciation For The Real Estate Beginner That Will Maximize Profits

Rental properties generally produce four forms of income.

  1. Cash Flow
  2. Property Appreciation
  3. Principle Reduction
  4. Tax Benefits

We are going to dive right into the fourth form of income, specifically rental property depreciation.  The IRS allows residential rental properties to be depreciated over 27.5 years.  This depreciation does not include the land value and only the building or structures on the property.  This value is a tax deduction, lowing your total taxable income.  When starting depreciation, remember to use only the building or structure cost.  The IRS has specific requirements on how to access the building value.  We recommend using your local municipalities property tax appraisal if they breakout the land value and improvement values separately.

As we all know, real estate generally appreciates, which is why the IRS requires investors to recapture the depreication as ordinary income when the property is sold.

There are three ways to avoid recapturing the depreciation.

  1. Changing the use of the property- Changing the property use to a primary residence will void the depreciation.
  2. Exercising a  IRS 1031 Like Kind Exchange.  This allows the deprecation bases to be moved to the new property, thus avoiding paying the recapture pently.  Like kind exchanges are complex and will be the subject or future post dedicated to the subject.
  3. Inheriting a property.  Properties left as inheritance not only avoid the recapture requirements, the depreciation is stepped up to the current value of the structures.

The decision to depreciation a property is generally considered a good decision and a absolute if you think your investment will fall into one of the three categories listed above.  This is truly one of the hidden gems of investment properties and considers a serious look.  As always, tax laws are complex and always changing,  you should discuss in detail with a CPA depreciation benefits prior to purchasing a property.

 

Reasons Why Real Estate (Rental Properties) Will Always Beat Stock Market Returns Part 1

Reasons Why Real Estate (Rental Properties) Will Always Beat Stock Market Returns Part 1

Through the years, I have invested in everything from stocks to precious metals, even making a short unsuccessful attempt at currency trading.  While a diversified portfolio is essential to mitigate risk, too many people completely overlook real estate, instead focusing on traditional securities, particularly stocks.  In this two-part article, we will compare stocks to rental properties, focusing mainly on security (part 1) and typical returns (part 2).

Part 1: Stocks are subject to changing market conditions, complex regulations and economic policies.  Past companies once regarded as titans in their respective industries can now be found in the bargain bins of stock exchanges. Sears, the once the dominate player in mail order catalogs and department stores fell victim to the big-box retails, who now battle existence with the E-Commerce business. CD stores, once a staple at every mall, permanently rolled down the store-front grills as consumers chose digital formats as their preferred music medium. Risking lending, ridiculous loan products and extreme leverage forced century old financial institutions into bankruptcy and federal bailouts. Detroit, once a symbol of American manufacturing featuring the “Big Three” is now a city in decline as a result of overseas competition, and rising manufacturing costs.

In contrast, the federal government provides housing-friendly regulations, tax incentives and programs as it views housing as the American dream and vital to the economy. The rental industry is not a commodity, but rather a necessity as it provides one of mankind’s most primitive needs: shelter. Historically, housing has maintained a steady appreciation. The median home price from 1940 to today has increased from $30,600 (adjusted for inflation) to $234,000.

However, real estate is not immune to losses. For the first time since the great depression, housing saw widespread property losses. Despite these losses, rents maintained and provided a life raft for landlords to weather the storm. What started as a disaster, became the biggest buying opportunity in decades for landlords.

A company’s stock performance can be directly impacted by the board of directors and by CEO decisions. For example, in 2000 Blockbuster chose not to buy a new capital-strapped company called Netflix as it feared Netflix would cannibalize its core industry. Enron once a blue chip and must have in many mutual funds collapsed as a result of massive deceptive fraud. As a landlord you are solely responsible and knowledgably of all the financial handlings and deception is impossible.

As the Dow Jones Industrial average (a stock index consisting of 30 companies) continues to break records, it is important to note, not one company has remained on the index since its inception in 1897 and many recent members have received federal bailouts or filed for bankruptcy.

Check back with Landlordwire.com between football and turkey this Thanksgiving for part 2, a detailed look at both rental property and stock returns.

Investment Property Mortgage Requirements

Investment Property Mortgage Requirements

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I like to think of the rental-property investment cycle as four phases:

  1. The Fun – Searching properties and negotiating the deal.
  2. The Reality – I am under contract and I need to pay for this property.
  3. The Work – Managing and maintaining the property.
  4. The Payoff – The sale of the property after years of mortgage amortization and property appreciation.

This article will focus on the reality phase, specifically, the investment property mortgage requirements.  Since the housing bubble and great recession, mortgage lending requirements have tightened.  New laws (primarily Dobb Frank Act) have made lending requirements standard, regardless of the mortgage broker or financial institution who writes your loan.  Ultimately, all loans will be securitized by either Fannie Mae and Freddie Mac. I have detailed below their current requirements.

Mortgage note quantities: Fannie Mae allows only 4 total notes, including a primary residence, while Freddy Mac allows 6 total notes.

Mortgage type: All investment properties require conventional loans and will not qualify for FHA (Federal Housing Administration) financing.

Debt to income (DTI): The maximum allowed DTI is 45%.  DTI is your total monthly debit obligations divided by your total monthly gross income (before taxes).  Generally, income from investment properties are calculated at 75% of total income.  Please note, losses on a property shown on your taxes will void that properties total income.

Cash reserves: 6 months principle and interest of your primary mortgage and all investment properties.  401K savings can be used to meet these requirements.

Down payment:  15% minimum with PMI (private mortgage insurance).  However, many PMI providers will not insure investment properties.  Therefore, it is best to plan on 20% down.

PMI amount: PMI amount will vary depending on DTI, credit score and down payment.  With 15% down you should expect a yearly cost of about .5% of the loan amount.  PMI is not required when 20% down payment is provided.

Mortgage rate: Mortgage rates for investment properties are generally .5% to 1% above the current convention loan rates.

Documentation: Bank statements from the last two calendar months, 2 paycheck stubs from the last 2 calendar months, last 2 years of tax returns, proof of reserve funds, mortgage statements and insurance declaration for all of your properties that current have mortgages.  The underwriter always has the right to request additional information, but the above is usually all that is required.

Mortgage requirements and laws are always being amended, and I encourage you to discuss the investment property mortgage requirements with a local mortgage broker or bank.  Good luck on your investment and enjoy the financial rewards of being a landlord.

 

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Why Real Estate Should be a Third Leg in Retirement Investing

Why Real Estate Should be a Third Leg in Retirement Investing

As a young professional, I realized retirement in today’s world required more financial planning and long term goals than our fathers before us. I looked at retirement as a three legged stool. Most people simply achieve two legs of their stool through social security and passive involvement in a work place sponsored 401K plan. I was no different until I turned to real estate investing as my “3rd leg”. I quickly watched as this leg became the concrete pillar of not only my retirement, but my financial freedom.

Today is the time to become a landlord. Today’s market features two unique conditions that has made renting properties now one of the most profitable times in our history. First, home ownership is at the lowest levels since 1965 (Bloomberg). The millennials have overwhelmingly chosen renting as their preferred housing accommodation. These two factors have been the catalyst behind record increases in rental prices. Rental rates are estimated to increase 8% nationally this year (Fortune.com). The demand for rental housing should remain strong and increase as the economy continues to create more jobs and as more millennials continue to become independent. Second, mortgage rates continue to hover near historic lows (currently around 4% for a 30 year fixed rate mortgage). Mortgage rates are benchmarked on treasury bills and treasury bills are based on the inflation within the economy. With inflation likely to remain stagnant, we can expect to enjoy these great borrowing conditions for some time.

Through calculated buying, smart leverage and common sense renting policy, you too will find success as a landlord.