Buying a rental property or converting your current residence into a rental when you upgrade your home can be an exciting investment opportunity with unique wealth building and tax advantages. But making the leap into the world of owning and managing rental property isn’t a decision to be taken lightly.
Let’s take a look at what makes rentals such a great place to put your money, but also be honest about what it means to be a landlord.
Regular cash flow + appreciating asset
Rental property is a unique asset class as it earns you money in more ways than one. Owners receive monthly cash flow from rent while the real property itself typically appreciates in value over time.
This means extra income in the short term and a larger net worth over the long run. Depending on market conditions where you buy, a rental can potentially “pay for itself” over the years.
Finding the right property
Choosing a single-family home for your rental is not all that dissimilar from house shopping for yourself. Properties featuring a great location near good schools, parks, shopping and other amenities will attract more reliable, responsible tenants.
Of course, these homes require a larger up-front investment, so you’ll need to crunch the numbers to make sure your expected rent covers the mortgage and all related expenses.
Purchasing distressed properties or homes located in less desirable locations is a risk/reward venture that isn’t for everyone, as managing low-priced rentals tends to come with additional challenges.
Note: Take special care when purchasing a condo, townhouse or any property that is part of an HOA. Homes that belong to an association often have restrictions regarding owners’ rental rights, particularly for short-term rentals. Be aware that even if the current covenants appear to be landlord friendly, there is no guarantee that the rules won’t change.
Rental property investment options
In addition to single-family homes, other real estate investment opportunities include:
- Multi-Family Properties: Investing in duplexes, triplexes, or apartment buildings offers multiple income streams from a single property.
- Vacation Rentals: Short-term vacation rentals listed on platforms like Airbnb or VRBO can be lucrative.
- Commercial Properties: Office spaces, retail buildings, industrial units, or functional land can provide stable, long-term rental income.
Planning for financing
A notable advantage to real estate investing is the ability to leverage capital from the bank. Most investors take out a mortgage loan to purchase rental property but depending on your goals, paying in cash might be the smart choice.
Be sure to consider:
- Investment property loans typically require a 20-25% down payment
- Loan terms are generally less favorable compared to rates and options available for your primary residence
- Factor in closing costs, inspection fees, and other transactional expenses
- Plan to hold cash reserves for each property, to cover maintenance, repairs, and vacancies
Real estate is rarely a passive investment
Unlike investing in stocks, bonds or cash instruments, owning property is more hands on and requires involvement on your part.
You will be responsible for:
- Finding responsible tenants who pay on time
- Screening applicants for income, employment, credit history and references
- Collecting, holding and returning security deposits
- Managing lease agreements
- Regularly checking in on your property
- Dealing with ongoing upkeep, maintenance and repairs
- Addressing tenant concerns
- Insuring your property
Hiring a property management company can offload most of these duties to someone else, but also eat into your profits. Bear in mind that outsourcing management doesn’t necessarily turn your property into a “set it and forget it” investment.
All that said, for investors with the right temperament, owning rental real estate can be very profitable and build long-term wealth.
Rental property and taxes
Real estate investments feature unique tax benefits and considerations. Always consult with your tax advisor to maximize potential deductions while remaining compliant.
- Rental income is generally taxable but can be offset by deducting expenses related to owning/managing your property, including property management fees, insurance, repairs, and mortgage interest.
- Deducting depreciation is a technique for reducing your taxable income by writing off the cost of the property over time.
- Passive activity losses can offset gains from other passive income sources. While rental losses may be limited, they can often be carried forward to offset future rental income.
- A 1031 Exchange is a strategy to defer capital gains tax from the sale of a rental by reinvesting the proceeds into another investment property.
Implications of selling rental property
Understand that selling a rental property works differently than selling your primary residence. You will likely owe capital gains tax on the profit from the sale and may need to recapture a portion of any depreciation deductions you took over the lifetime of owning the property.
Always consult with your tax advisor before selling rental property to explore tax-saving strategies.
Get professional guidance for real estate investing
The tax and business advisory team at Accountability Services have helped many rental property owners make smart business decisions at every stage of the real estate investment process – from the initial buy to property management, through to the sale of a rental unit.
Whether you’re a beginner looking for your first rental or an experienced investor navigating a complex commercial deal, give us a call to discuss your specific real estate investment goals. We can help you analyze your options and create a strategic plan for maximizing ROI and tax benefits over the life cycle of your investment.