Buying residential housing offers the best
investment for relatively little risk if
done conservatively. Whether you buy home or
a house to rent, tax laws, leverage, and
demand help you to acquire and grow your
real estate investment. This article shows
you how.
Tax advantages on selling
Investing your money
directly in either your home or a house to
rent out offers significant tax advantages.
Both home ownership and residential property
gains are subject to the low capital gains
tax when sold.
And, for your own home,
you can exclude a high amount of gain -
$250,000 if single or $500,000 if married –
when you sell. This often eliminates capital
gain tax on it altogether.
Tax advantage on
holding property
Very few of us can buy a
house with our own cash. We need a bank to
help us buy it; and that’s done with a
mortgage – i.e. a loan from the bank.
We put a fraction of the
house price down (for the seller) and have
the bank pay him the balance. The balance is
the principal mortgage loan amount which we
pay back typically over 25 or 30 years in
monthly payments.
Each monthly mortgage
payment includes a portion for interest with
the balance of the payment going toward
paying off the principal of the loan. The
principal payment portion eventually kills
off (amortizes) the loan.
For a 25-year mortgage,
early payments are mostly all for interest
payments; ending payments are mostly all for
principal. At about year 18, the interest
and principal portions of each payment are
equal. So it takes 10 years or more before
you’re reducing the principal you owe
significantly.
Tax laws favor using
mortgages since it allows you to deduct the
interest portion of your mortgage payments
from your income. This helps you ‘hold’ your
property – whether you’re a homeowner or
buying the house for its rental income.
Homeowners deduct the
interest portion of their annual mortgage
payments on their Schedule A (itemized
deductions) of their 1040 Income tax form.
These sizeable deductions reduce the amount
of income tax that homeowner’s have to pay –
and so help them to be homeowners rather
than renters. Remember, too, that if they
didn’t own their home, people would have to
pay rent anyway.
Rental income owners
claim their rental income on a Schedule E
(Rentals) but they also get to deduct not
only their annual mortgage payment interest,
but also other annual costs of owning the
rental property such as maintenance expenses
and an annual depreciation amount. These
deductions can help reduce taxes paid not
only on the rental income itself, but
sometimes on the investors own personal
taxes on his form 1040.
Leverage
Because most housing is
bought with a mortgage, your investment in
the house is originally the amount you put
down – called the equity. Your equity is
always the value of the house less the
mortgage amount you owe. Since the bank’s
mortgage claim is fixed, any increase in the
value of the house directly increases your
equity.
Leverage makes your
equity growth rate grow faster than the
house’s value – and that can mean a high
investment rate for your investment. As long
as you put enough down for your initial
investment and maintain your income, you
should be able to weather most market
downturns.
As an example of equity
growth, consider you put 20% down for a
$100,000 house – which gives you $20,000 in
house equity and an $80,000 mortgage. If
house prices rise just 4% over the next
year, your $100,000 house become $104,000.
Though you still owe about $80,000 on the
mortgage your equity is now $24,000. That’s
a 20% equity growth rate – a high
investment!
Demand
People need to live
someplace and the number of people is always
increasing. This pretty much keeps housing
prices going up – generally about 4 or 5%
per year over the long run.
But, because buyers most
qualify for mortgages, interest rates affect
not only the numbers of buyers but the house
price they can bid for. Lowering interest
rates allow more people to qualify for
mortgages – and to bid higher on a house.
This causes temporary upward pressure on
housing prices. The reverse occurs with
rising interest rates. But these effects are
shorter term and put peaks and dips on the
relentless rise in prices.
If you put enough down so
as not to be too exposed to holding costs
and can maintain your income for your own
house, or rent income for your rental, you
should be able to hold out through various
economic downturns. Then your responsible
level of leverage will help you grow your
wealth faster than most other forms of
investment.
