Homeownership is the cornerstone of personal wealth. Real estate is a high-value asset; owning property serves as the foundational basis for a nest egg that can sustain you and your family throughout retirement. According to a recent Motley Fool article, the typical homeowner has more than 80 times the wealth that renters do with home equity, along with retirement investments, accounting for approximately 60% of their net worth.
Homeownership is the key to building a strong and sustainable financial base for you and your family. Today we’re going to look at the concept of equity coupled with savvy real estate investment strategies designed to help you build a suitable nest egg.
Equity Over Time
The most well-known method for building personal wealth through real estate holdings is equity over the long term. Building additional home equity works via two different mechanisms.
Homeownership is an investment vehicle much the same as trading stocks, bonds, and securities. With a financial instrument such as a simple index fund, a typical investment strategy involves putting money into an index and then letting it sit and appreciate over the long term. This is based on a core economic concept known as the “Efficient Market Hypothesis,” which in layman’s terms means that a market will always trend upward over time. The real estate market follows a similar trajectory.
While there are no solid guarantees, over time the value of your home can be expected to appreciate in value on a yearly basis. Appreciation is tied to the strength of the overall housing market, but given its typical performance over the last decade, it is reasonable to see a 3.5 to 3.8% increase in your home’s value every year.
Equity, on the other hand, is the difference between what you’ve paid towards your mortgage and your home’s overall value. Equity represents your stake in the property. With regular mortgage payments made over time, your equity in the property increases.
Once you’ve completely paid off your mortgage, you own the home free and clear. It becomes 100% your asset, which in turn is added to your personal net worth.
Using the 1031 Exchange Rule
Ask almost any property owner, and they can tell you about appreciation and equity, but not everyone knows about the 1031 Exchange Rule.
If your home were to appreciate steadily at 3.5% per year, you’d be responsible for paying capital gains tax when you go to sell it based on the fact that homes are considered capital assets in the eyes of the IRS. Depending on the market value of your property, capital gains tax can make a huge impact on your personal wealth. The 1031 Exchange serves as a way to mitigate that impact.
With a 1031 exchange, also known as a like-kind exchange, you sell your property then give the proceeds to a third-party intermediary who uses that money to buy a new property for you. Essentially, this serves as a way to defer the realization of your capital gains and keep your property investment growing. In most cases, you are only taxed on the difference in sale price. While there are many extenuating circumstances, loopholes, and sub-regulation involved, the 1031 rule generally keeps your investment capital in your hands and working for you rather than in the hands of the IRS.
Make Your Money Work For You
Investing in real property is one of the best ways to build your personal wealth. The rules and regulations surrounding real estate investments can be incredibly complex, however. If you’re looking for a real estate partner that can help you navigate beneficial programs like the 1031 Exchange Rule, I’d love to talk with you. Amy Alpeza Real Estate is dedicated to helping.