Consider a real estate investment over a 10 to 20 year time horizon to diversify your investments for the long term.

The following spreadsheet shows the costs and tax advantages that can be gained through a real estate investment.   Press Right Click on your mouse, select Open in New Tab or New Window.

We identified a home in the suburbs of Chicago that sold for $235,000. For illustration purposes, the home and mortgage was acquired on January 1, 2011.

The purchaser placed a down payment of 20%, $47,000, on the property and financed the remaining $188,000 at 4% for 30 years. An amortized, 30 year mortgage would require annual total payments of $10,872. An interest-only mortgage, at the same rate, would cost just $7,520 annually. Since we would expect price appreciation over time and are not averse to paying mortgage interest (as it is a tax deduction), we would favor the interest-only mortgage if we could obtain it.  In this case, we will show the interest only mortgage.  We can pay down principal if and when we wish.

Assuming taxes and maintenance expenses as listed in the spreadsheet, along with the interest on the mortgage, our annual expense is $17,390. Rental for the property is estimated at $1,735 per month or $20,820 per year.  Our net income is $3,430.

Rental residential real estate is depreciated over 27 ½ years meaning that you can write off an additional $8,545 for 27 ½ years as a cashless depreciation expense (note: you cannot depreciate land.  The numbers here are just estimates). Your Schedule E tax form would include interest, maintenance, depreciation and a number of other expenses to arrive at a net gain or loss for the year. In this case, the depreciation expense of $8,545 eliminates the net gain (for tax purposes). You have a net loss of $5,115 for the year.

If you have an income of less than $100,000 and actively participate in the management of the property, you can write off up to $25,000 of losses against your gross income.
With this in mind, it’s important to see that developing a comprehensive financial plan is often important in order to manage your taxable income to take advantage of tax breaks that phase out as your income increases.

Assuming that you are able to rent out the property and that you reinvest net profits as well as tax benefits, line 44 shows the net cost of your investment. You start in year 1 with an investment expense of $235,000 The first year shows a cash profit of $3,430 (line 36). Yet with depreciation, you have a tax loss and your taxes are reduced by $1,279, nearly $5,000. This could be the money that funds your IRA.

After 26 years, based on this scenario, you have recouped your entire investment through rental income profits and tax reductions.

Based on a modest 3% growth rate, your property is now worth $506,000 and your mortgage balance remains at $188,000.  If you continue to hold the property in retirement, it should continue to provide you with a steady income stream.  Should you wish to sell the property at that time, again consult your fee-only financial planner to determine tax-efficient ways to sell the property.

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