Rental Income Through Real Estate Investments
Passive Income Through Real Estate Properties
Real estate investments are a great way to increase your monthly cash flows. Rental income can be accomplished through the simple expedient of parking your excess cash reserves in a rental property. A residential rental property can be leased out and thereby accrue income. The results would be earned income separate and distinct from the one you have already been making. Most of the mature investors would prefer to rental income investments over capital growth investments.
Renting out a property to increase your monthly income is very simple to understand. It is also straightforward to implement. Here is how it works:
Purchasing the property
You have to first acquire the property either through utilizing any financing or even cash up front. However, it is prudent to purchase only those properties that can easily be rented out. Make sure you buy properties that have a very high monthly rental yield on average.
A high monthly rental yield means that it is imperative that their monthly rental income should be (considerably) higher than the total of the expenses that may be required to maintain that particular property.
The main reason why properties are rented out is to ensure rental income. Some expenditures may regularly accrue due to the ownership of the property. Here, you should remember that the goal of renting out the property is not just to pay off its expenses.
The goal is to earn a handsome monthly profit. Basically, the idea is to ensure a tidy sum of money that may be incorporated into your monthly income. Tenant pays the months rent in advance whenever it is stipulated in the contract of the rented the property.
The best part of renting out a property is the fact that it can quickly generate real income. Let us see how it works in a real-world situation through the following example:
Rental Income Example
Ms. Jane Doe has just retired from her job and has been given a substantial gratuity from her grateful employers for her years of faithful service. Under the circumstances, the best possible means of earning a living without losing her liquid cash reserves will be to acquire a property that she would be able to rent out as soon as possible. Furthermore, the rent income has to be higher than the monthly expenses (maintenance, taxes, etc.) of owning the property.
Keeping this specific aim in mind, she should choose to invest in commercial or residential properties. Large commercial properties will be able to generate for her a strong return on her overall investments.
Here, she has to check the annual ROI (return on investment) ratio to be able to ascertain that the considerable investment is justifiable and to what extent. If for instance, she has determined that her monthly gross income should not be less than $600 (over and above the property’s expenses), then the rental property has to be able to generate the desired amount in rental income to be able to justify the cost incurred in its acquisition.
Rental real estate passive activities are why whenever you consider acquiring rental property to earn profit by renting it out, and it is imperative that you take into consideration the above points to ensure that it pays you rich dividends in the long run.
Cash Flow vs. Capital Growth
The kind of strategy that you may opt for when you decide to invest in property will depend almost entirely on your very own outlook towards that particular investment in question. Broadly defined, there are two major types of objectives concerning any residential rental property related investments.
These include the following:
- Cash flow
- Capital investment
However, before you decide on either of the options mentioned above, you need to know why either of the two strategies is the right one for you.
Cash Flow option
A cash flow strategy is by far the simpler of the two. Cash flow is inherently a less complicated strategy when compared to capital gains.
It involves investing only in commercial, multi-family properties, or residential rental real estate. The type of properties that tend to give a markedly high rental yield per annum. A high rental yield essentially means that the overall rental income of such a property is significantly higher than the expenses required to keep it.
The key to maintaining cash flow is to ensure that the property offers a high rate of rental income. The rental income must cover the expenses associated with the ownership of the property, which means that maintenance and property taxes will be paid in full. Also, there will still be a hefty sum left over every month that will be incremental to the income of the property holder.
In the short term, this strategy sound reasoning. On the other hand, rental income properties can have some disadvantages. The first one is the fact that most of these type of properties are non-liquid assets. Another disadvantage is that when the property is sold, the amount might be lower unless the property has been kept in mint condition.
Capital Growth investments
From a short-term perspective, most people will agree that it is an ideal strategy. Many proponents and experts in the real estate field tend to prefer it over the cash flow strategy, especially when buying a house.
They believe it is possible to increase your real wealth by merely purchasing properties in places where there is a steady increase in prices. Within a few years, the property market may even double. You will be able to reap the windfall of your investment. However, the main drawback of this strategy is that there is no ‘immediate return’ flowing from your investment. You have to basically invest and sit tight for the market prices to increase. Sit tight until you are in a position to sell off your investments. The number of years you may have to wait is entirely dependent on the whims and caprices of the real estate market as a whole.
In conclusion, we can say that whatever strategy you opt for has to be based entirely on your own needs and personality. If you want immediate returns, then the cash flow is the ideal strategy for you. However, if you are willing to be patient, then the capital investment might be the thing for you.
Flipping vs. Long Term Investments
When considering a real estate investment, you have to focus on either one of two main strategies. They are:
- Long term property investments
Once you have purchased property for investment purposes, then you can either decide to hold it as a ‘long term investment’ till the time you choose to liquidate your investment by selling the property. Or you can ‘flip’ it by selling it within a brief period.
Both of the following strategies have their very own pros and cons.
The advantages and disadvantages of flipping
The most significant benefit by far, of flipping your property investments is that it is quite possible to realize the capital gains immediately. Just make sure that your capital does not remain tied up for extended periods. Unlike the securities and stock markets of the world, property prices won’t change their values multiple times a day. The property market, in contrast, is relatively more easily predictable. The market can give the investor time to flip properties. Most of the time, they have more control over the investment. Therefore they can make a certain amount of profit from each investment. Here, flipping properties is a markedly, less risky investment strategy when compared to most other types of liquid investments.
However, it is pertinent to note that flipping properties can easily create cost and tax issues.
Pros and cons of long term real estate investments
When it comes to real estate investing, many experts opt to prefer long term real estate investments over flipping homes. Most of the time is because land prices almost always tend to recover in the long run (especially in urban areas).
Also, barring on a catastrophe (such as the Chernobyl nuclear disaster, for instance), prices are almost guaranteed to rise. The land is limited, and the steadily increasing populations tend to ensure that even after a recession in the market, prices eventually tend to creep upwards.
On the other hand, long term investments are extremely capital intensive. For an extended period, they are completely tied up to the investor’s capital. Apart from that, the owner has to take care of the property. He pays all applicable taxes and spends on the upkeep and maintenance of the property.
Most of the rental expense end up being included in the investment cost of the subject property. So, when the time comes to sell, real estate investors have to ensure that the listing price at which they sell is not only higher than the original purchase price. Calculating the rental income and expenses will determine the amount they spent on its overall upkeep. Also, they continue to vector in the cost of inflation.
Ultimately, both of these investment strategies have their own pros and cons. They are entirely dependent on the personal attitude of the investor. Finally, most of the residential rental property investment advice will be available to them courtesy of their real estate agent.
If you don’t have experience with rental activity or property management, it is best to consider working with management companies to administer the investment. Real estate agents can also manage some rental income properties but depends on local laws and regulations.
For smaller residential rental income properties, a real estate agent will be the best option to use. Realtors will be capable of managing vacation homes, and they can ensure that the tenant pays the months rent on time. On the other hand, for large commercial projects, you should consider utilizing management companies.
As an investor, you want to protect your investment by hiring a qualified business capable of collecting advance rent at fair market value. Many of the monthly expenses in a rental property are subject to change without notice during the investment period. Management companies are capable of dealing with income and expenses situations are vital to avoid a rental loss.
How can rental income improve your personal finance?
Adding multiple income streams to your personal finance is the best way to achieve economic freedom. Generating passive income from different passive activities like real estate rental activity can eventually lead to eliminating the need to exchange time for personal income.
Working different strategies with a financial advisor for early retirement planning is always good to do. Also, meeting with an attorney for estate planning can be great for your future beneficiaries, especially if you have actively participated in multiple business activities, or if you hold assets in the stock market.
Everybody’s personal finance change without notice very rapidly. It is always good to have a retirement guide or a financial advisor. He or she can provide you with different estate planning strategies and other passive activities such as rental income.
Most real estate rental activity comes with passive activity loss limitations. Such events allow you to protect your self from massive rental loss. With extensive commercial rental properties, when you take the total gross income and deduct expenses, the net amount of earned income will be sufficient to cover financing and leave you with positive cash flow.
Taxes on Rental Income
Every year you must report your rental income taxes on your tax returns. When tax season comes, it is imperative to have an accountant on your team to help you file taxes every year. A tax expert can help you with filing your taxes and can apply your tax deductions according to your situation.
Working with an accountant that has experience with real estate tax law and with business taxes as well would always be better than taking tax tips from someone that has not worked with taxes on rental income before. Whenever tax time arrives, you should consider including all your gross income received from your tenant’s as direct deposit or even if it was deposited to your bank account.
Ask your accountant what the difference between a married filling or filing separately. Most real estate expenses can be tax deductions when you are renting a property. According to the IRS publication 527, rental properties can qualify for section 1031 exchange if they meet specific qualifying use standards.
It is essential to work with an accountant when it comes to tax payment or any tax topics in general. A good tax preparer can identify all taxable income when it comes to filing your tax returns.
The most common rental income are advance rent, lease cancellation fee, expenses paid by tenants, security deposit deductions, and any property or services received calculated at fair market value. For more information about what is considered to be taxable income, visit the IRS publication 527.
One of the benefits of passive income through real estate rental properties is the ability to deduct expenses on your tax returns. Some of the most common rental expenses are HOA fees, property tax, depreciation, mortgage interest, and restoration or repairs done to the rental property.
Working with a competent tax prep or accountant will give you a piece of mind. You should be careful to work with someone that can keep your social security and personal information safe. Also, work with someone who is up to date with the latest tax reform.
Even though there are excellent online tax preparation services like HR Block, we always recommend our clients to use an accountant to help them complete the supplemental income and loss limitations tax form. Having expert guidance from an experienced accountant is better to tax prep than filing your taxes online with tax software.
Modified adjusted gross income
The internal revenue services use (MAGI) modified adjusted gross income to determine if an individual can qualify for any tax deductions. A tax expert can also help you determine whether you can deduct any passive losses from your rental activities.
MAGI can be calculated after a taxpayer determines the adjusted gross income (AGI). The AGI can be obtained by subtracting the deductions that he or she qualifies for from the total gross income. Knowing your adjusted gross income is crucial because it dictates how much tax credit you can apply for, or if you are eligible for any premium tax credits. AGI is determined before any standard deductions.
Premium tax credits can also be used to buy individual health insurance at a discount price. Working with an experienced accountant can be very helpful when it comes to the amount of rental loss allowance and expenses deductions on your income tax or federal tax declarations.
Rental Property Depreciation
Rental activity is very lucrative used by many real estate investors for passive income. Depreciation is a benefit available for investors to deduct a portion of the money they have invested in a real estate property from their gross income received each year of such rental property. This particular benefit is also called Tax Depreciation or Cost Recovery.
You cannot include land value for depreciation purposes. The cost basis for depreciation will consist of any improvements and closing costs.
A single-family house was purchased for $105,000, and $5,000 for the closing costs. An appraisal indicated that the land is worth $10,000. The tax basis or cost basis for depreciation is going to be $100,000 for this rental property.
Current tax law allows residential owners to depreciate their investment over 27.5 years on a straight-line. An accounting tax expert can be useful to help you determine the amount of depreciation you can deduct when you file taxes. Hence, he or she is going to maximize your tax refund if applicable to your situation.
Rental income is a great tool when it comes to passive activities. Utilizing an accountant can help you during tax season. If you start to think about retirement planning strategies, you should consider rental properties for asset allocation. Having that extra income can help you eliminate any personal loan, credit card debt, or even old student loans.
You can still use the new online tax services like TurboTax or HR Block, and they also have an excellent mobile app. Most of these companies are very famous, and they are also clear about what fee applies when filing your taxes through their tax software. HR Block offers a free income taxes calculator.
On the other hand, If you are serious about having multiple passive income streams, it is imperative that you add an accountant to your team. He or she can maximize your earned income credit, applicable tax deductions, file taxes online, and more. For more information about registered trademarks and tax law, you should always talk to an attorney. Visit Wheres my refund to check your tax refund status.
Finally, visit our real estate guides for more related articles and real estate information.
Note: The tax information, tax tips, or tax advice received in this article should not be considered as legal tax advice. We strongly recommend you meet with your financial advisor, tax expert, or a certified accountant for any real estate tax information.