Investment real estate offers several different returns to a purchaser. As far as the IRS is concerned as long as you aren’t living in a property as your personal residence you can call it an investment property. The following is a list of those returns;
- Cash flow. This is the return that is left over from the income from a property after paying all the operating expenses and the loan payments if the property is financed.
- Equity growth from loan reduction. When an investment property is financed and this loan gets paid off from tenant income that is a return to the investor. This does not create any immediate cash flow income but as the loan is paid off the equity of the owner increases over time and eventually the entire loan can be paid off from tenant income thereby eliminating the mortgage payment.
- Equity growth from appreciation. A better word for appreciation would be inflation. Most commodities in our world cost more over time because our currency loses value. A current example is gas. A few years ago gas was about $2.00 per gallon and now it’s over $4.00. Same gas it just takes more dollars because they aren’t worth as much. The same thing happens to real estate over time. This increase in price wouldn’t be a return, or benefit, to the owner if the property was bought all cash but it will be if it was purchased with a loan and a normal down payment.
- Tax benefits. The tax laws for investment property allow the owner to claim deduct all the costs of running a property from the income from that property. In addition you can deduct any interest on borrowed money and depreciation on the property. Depreciation is an allowance that you get to deduct against income to help you replace the structure on a property once it wears out in the future. It is not a real current expense that takes cash to pay but what we call a “paper loss.” This paper loss helps shelter some of the net income of the investment from taxes and this tax savings is a return to the investor.
- There is one final return that can have huge advantages to the real estate investor and that is the tax deferred exchange. The tax codes allow an investor to sell a property at a profit and as long as ALL the proceeds are used to buy another property there is no tax due at that time. The obvious advantage is that the investor gets to actually use money owed in taxes to help with the next investment that is made allowing the investor to buy more property.