With the bigger bite the Feds want to take out of your income for taxes, don’t you think it would be smart to start sheltering some of your income with rental property? Okay, let’s consider your alternatives. You hide your “nest egg” under your mattress or you place it into a CD and wait for the economy to improve-yes, just the way your grandfather or father might have done before you. Fair enough. But this economy is not the same as the one that your grandfather or father faced. In fact, they wouldn’t recognize the challenges that you are facing.
The idea of just leaving your money tucked safely under the mattress or in a bank account might feel secure but it isn’t going to cut it. The money under your mattress will eventually be eaten away by inflation (yes it will, sooner or later, and perhaps quickly). And whatever money you have in a CD (for all intents and purposes) is just collecting dust because you are probably earning just 1-2%; and hey, if you haven’t noticed, that isn’t even keeping up with inflation.
So what is a hard working stiff like you (and me, by the way) supposed to do? The truth is that we must consider investing in real estate so we can shelter our income and perhaps at the end of the day maybe even make a few bucks profit.
Here’s how it works.
An owner of an investment property takes in taxable rental income and pays out tax-deductible operating expenses like insurance and repairs resulting in a “net operating income” on which taxes must be paid. However, the tax code permits further deductions.
With an income-property investment you can deduct mortgage interest. The benefit to an investor here is that interest is not really a cost associated with operating the property, and in reality will get paid (along with your entire mortgage) by the tenants. So this IRS allowance is a sweet deal for real estate investors.
A depreciation deduction is the other source of tax shelter beneficial for those who own rental property. In this case, at the same time the market value of an income property is undoubtedly increasing over time, the tax code makes the assumption that the buildings are wearing out over time and allows investors to take a deduction for that presumed decline in value.
But here’s where it gets really exciting. Depreciation (or cost recovery as it’s now called) is a non-cash deduction. It doesn’t affect your cash flow and you aren’t required to shell out money to get the deduction. Depreciation deductions are merely taken and thereby provide an excellent way to shelter income without additional cost. Moreover, in cases where the deduction is large enough, it can also provide shelter for other investment income as well.
Okay, here’s the concept in very simplified fashion.
less Operating Expenses
= Net Operating Income
less Mortgage Interest
= Taxable Income
If you’re new to investing, of course, the toughest part (not unlike any new venture) is getting started. But with a systematic plan for investing in real estate you can succeed the same way others have. Here’s a suggested approach consisting of five phases: (1) Learn about real estate as an investment vehicle. (2) Research the market in your local area. (3) Plan how to invest your money. (4) Invest your money according to your plan. (5) Manage your investment to meet your goals and objectives.
You get the idea. Educate yourself, build an investment plan, make your move, and then roll up your sleeves and stay involved.
Two other words of advice you might want to consider. Make your first investment a conservative one; don’t try to hit a home run your first time at the plate. Secondly, get the resources to run the numbers yourself; you don’t want to base your real estate investing business solely on what others might be telling you. Here’s to your success.