Therefore, you might wonder, “Why should you buy or invest in real estate?” because it’s the best way to invest! Let’s talk about the reasons why investment real estate is a good investment in the first place. A well-known acronym that addresses the primary advantages of all investment real estate is the simplest response. Simply put, investment real estate is the best kind of investment. The IDEAL denotes:
• I – Income • D – Depreciation • E – Expenses • A – Appreciation • L – Leverage Real estate is the best investment out of all of the alternatives. I’ll go into detail about each benefit.
The word “ideal” refers to income. a.k.a. positive cash flow) Does it actually bring in any money? Monthly rents should be bringing in money for your investment property. Obviously, there will be times when there is a vacancy, but in most cases, your investment will be earning money. Be cautious because novice investors frequently exaggerate their assumptions and fail to account for all possible costs. Before making a purchase, the investor ought to be aware that the property will COST money each month—also known as negative cash flow. Although not ideal, this scenario may be acceptable in limited circumstances, which we will discuss later. It all comes down to the owner’s risk-aversion and capacity to finance and pay for a negative-producing asset. Many residential real estate investment properties experienced skyrocketing rents and exorbitant prices during the real estate boom. Numerous naive investors purchased properties under the presumption that the price appreciation would more than make up for the high mortgage balance’s monthly negative impact on funds. To actually achieve the INCOME portion of the IDEAL equation, be aware of this and try to forecast a positive cash flow scenario.
In order to ensure that your monthly cash flow is acceptable, it may frequently necessitate a higher down payment, resulting in a mortgage with a lower amount. In an ideal world, you would pay off the mortgage so that there is no doubt that you will receive substantial monthly cash flow. This ought to be an essential part of one’s retirement strategy. If you do this a few times, you won’t have to worry about money in the future, which is the main goal and the reward for buying investment property in the first place.
Depreciation is the meaning of the “D” in IDEAL. You can save money on taxes by using the depreciation of investment real estate. What exactly is depreciation? It is a non-cost accounting strategy for taking into account the total financial burden of investing in real estate. Another way to look at it is that when you buy a brand-new car, its value decreases as soon as you drive it off the lot. The IRS lets you deduct this amount each year from your taxes on your investment real estate property. Kindly note: This is not intended to be tax advice or a lesson in tax policy because I am not a tax professional.
Having said that, the length of time (recovery period depends on the type of property—residential or commercial) and the overall value of the structure of the property determine the depreciation of a real estate investment property. If you’ve ever received a property tax bill, the assessed value of your property is typically broken down into two categories: one for the land’s value and the other for the building’s value. Your total “basis” for property taxation is the sum of these two values. When it comes to depreciation, you can only deduct the structure’s original base value from your taxes; Due to the fact that land is typically only appreciated, the IRS prohibits depreciation. The structure on the property, like your brand-new car as it drives off the lot, is getting less and less valuable every year as its effective age increases. Additionally, this can help you save money on taxes.
The best illustration of the benefit of this idea is that you can actually turn a property that generates positive cash flow into one that shows a loss (on paper) when dealing with taxes and the IRS by using depreciation. Additionally, you can deduct that paper loss from your income for tax purposes. As a result, it is a significant advantage for those who are specifically seeking a “tax-shelter” for their real estate investments.