Creating wealth is undoubtedly a high priority for many individuals. While many will look to diversify their stock portfolio or increase their retirement contributions, one highly profitable approach is homeownership. In fact, for those who already have a sizable amount of liquidity, property investments are a great vehicle to build equity, diversify your investments, and help you build wealth.
Just like any other asset, there are a few key reasons why property ownership or real estate investment is great for wealth growth. Here are some of the most notable ones.
- Appreciation. While there is risk involved in real estate as in anything, many properties will increase in value over time. Whether the property is bought in cash or via a loan, this results in gains for the property owner. Likewise, if the owner has financial flexibility and the property remains occupied, they often have the freedom to wait out the market when it hits a rough spot. Home values have been in the double digits over the past decade in our region. The 3% average is likely national.
- Leverage. Residential properties are considered tangible assets, and leverage is the use of tools to increase an investment’s potential return. This means that you can borrow money to purchase a property without putting forth all the funds yourself. Thus, you have the opportunity to build a sizable return on investment without investing a huge amount of capital upfront, helping you preserve your liquidity.
- Tax Benefits. There are many benefits to owning real estate when it comes to taxes. This is particularly true with investment properties. When an investor or owner is renting their property out, they can make passive income via renting, and they can increase this income via operating expenses, business write-offs, and depreciation. This is a great way to invest your money, build equity, AND make passive income while having your costs covered by someone else.
- Inflation Protection. The decrease of the value of money over time is called inflation. Via inflation, we see costs increase with the diminished value of money. However, this can be a boon for real estate investors. For those renting properties, rental prices can be increased with no impact on loans or mortgage payments. This increases cash flow and helps the investor protect their wealth.
Once you’re involved in real estate investment, there’s no looking back. A critical facet of success is ensuring that you’re knowledgeable on how to employ existing laws and tax regulations to your benefit. One of the most important tools in property investment is the IRS’ Section 1031 exchange. So, what is it? And how do you use it?
The Section 1031 Exchange
While real estate investing is a great way to build wealth, one of the downsides frequently cited by investors is capital gains tax. Classically, a property owner will incur taxes on any gains that they make on a property sale, and they will be expected to pay those at the time of sale. However, the IRS offers an alternative option called a “like-kind exchange” under IRS Section 1031. This excludes property owners from having to recognize a gain or loss when they “exchange real property used for business or held as an investment solely for other business or investment property that is the same type.”
Translation? You can swap one investment property for another with few or no taxes at the time of sales (it will actually result in tax deferral), assuming it meets the constraints of a 1031 exchange. While this is limited to investment and business properties only, there are certain narrow conditions that allow investors to do this with a former primary residence or vacation home. Likewise, investors must consider any debt or liabilities they are holding on a given property. For example, if your overall liabilities decrease between like-kind properties, this is also considered a capital gain and will be treated as income.
Either way, the 1031 exchange allows capable real estate investors to grow their capital gains tax-deferred rather than pay out on taxes at that moment. This is a great tactic for savvy investors and new investors alike; consultation with a real estate investment expert is a great way to get started with this highly advantageous investment opportunity.
Conclusion
While homeownership and real estate investment may seem daunting at first, these are exciting tactics for portfolio diversification and wealth growth. For the new investor, it’s always a great idea to start with an expert by your side. Want to learn more? Contact us now for more information.