Things You Should Know Before Buying or Investing in Real Estate

Real estate is one of the most popular and lucrative forms of investment. Real estate can provide you with income, appreciation, tax benefits, and diversification. It can also help you achieve your personal and financial goals, such as owning your own home, building wealth, creating passive income, or leaving a legacy. However, owning and investing in real estate is not a risk-free or easy endeavor; it requires a lot of research, planning, financing, management, and maintenance.

If you’re a new or future lawyer who is interested in owning and investing in real estate, here are some things you should know before you start checking the local listings.

Buying Versus Investing

Real estate is a term that refers to land and the buildings or structures on it, as well as the rights and interests associated with it. One thing you should know is that buying real estate for your primary residence is different from investing in real estate to build wealth, from both a practical and tax standpoint. Buying a home is a personal and emotional decision that involves many factors, such as your lifestyle, preferences, family, location, budget, and more. Buying a home may or may not always be a good investment, especially if you live in a high-cost city where the property taxes, maintenance fees, and mortgage interest may outweigh the appreciation and tax deductions, or if you simply don’t plan to stay in an area for more than a few years.

However, buying a home as a primary residence also has some specific tax advantages, such as not having to recognize the first $250,000 of gain on the sale of your home for single tax-filers ($500,000 for married filing jointly), as long as you have lived in it for at least two of the last five years. You can also deduct mortgage interest on the first $750,000 of your mortgage debt if you itemize your deductions.

On the other hand, investing in real estate is a business and financial decision that involves analyzing the potential return, risk, and cash flow of the property. Investing in real estate may not always be a good fit for your lifestyle, especially if you have a busy and demanding career where you may not have the time or energy to deal with tenants, repairs, or legal issues. Some of the ways people invest in physical property are buying rental properties, flipping houses, wholesaling properties, or participating in crowdfunding platforms and co-ops.

Another way to invest in real estate without buying physical properties is to invest in real estate investment trusts (REITs). REITs are companies that own, operate, or finance income-producing real estate, such as office buildings, shopping malls, hotels, or apartments. They can be publicly traded or privately held, and they distribute most of their income to shareholders as dividends. By investing in REITs, you can gain exposure to the real estate market, diversify your portfolio, and earn a steady stream of income without having to deal with the hassle and cost of owning and managing properties.

There are some key differences between investing in REITs and investing in physical real estate. One difference is the liquidity of the investment. REITs are more liquid than physical properties, meaning you can buy and sell them more easily and quickly. However, this also means that REITs are more volatile and subject to market fluctuations. Another difference is the level of control and involvement you have over the investment. REITs are managed by professionals who make the decisions about the acquisition, disposition, and operation of the properties. Physical properties, however, require more personal involvement, such as finding tenants, collecting rent, maintaining the property, etc. Depending on your preferences, goals, and resources, you may choose to invest in REITs, physical properties, or both.

Tax Implications of Investing in Real Property

Another key piece to understand is the tax treatment of your investment. REITs are not taxed at the corporate level, but pass through their income to shareholders, who must pay taxes on the dividends they receive. Physical properties, on the other hand, are taxed at the individual level, but they also allow you to take advantage of depreciation, 1031 exchanges, and other tax benefits.

For example, if you invest in rental properties, you can deduct your expenses, such as mortgage interest, property taxes, repairs, etc., from your rental income and lower your net income from the property to generate either a profit or a loss. While real estate investing is seen as a passive activity (therefore generating passive losses that can only offset passive gains) in the eyes of the IRS, there are certain situations in which you can use passive losses from your real estate investments to offset your nonpassive income.

Another tax benefit of real estate investing is depreciation, which allows you to deduct the cost of the property over time from your income. For example, if you buy a rental property for $200,000, excluding land value of around $50,000, you can deduct $5,455 per year for 27.5 years. This lowers your taxable income on the property and therefore your ultimate tax liability. However, depreciation also reduces your basis in the property, which may increase your taxes when you sell it, unless you use a 1031 exchange to reinvest the proceeds in another property – yet another potential benefit.

Skills and Resources Required

You should also understand that investing in real estate requires a variety of skills and resources that you may not have or want to acquire. For example, you need to have a good grasp of the real estate market, trends, laws, and regulations, and be able to conduct due diligence, analysis, and valuation of the properties. You also need to have a good network of professionals, such as real estate agents, lawyers, accountants, lenders, contractors, and others who can help you with the transaction, financing, management, and maintenance of the properties. Plus, you will also need to have a good financial plan, budget, and reserve that can cover your down payment, closing costs, mortgage, taxes, insurance, repairs, vacancies, and more to ensure your positive cash flow and return on investment.

Real estate ownership and investing can be a rewarding and profitable venture, but it also requires a lot of knowledge, skills, and resources.

By knowing these things, you can prepare yourself better for owning and investing in real estate and achieving your personal and financial goals.

To discuss your real estate questions, schedule a free call with an Accredited Financial Counselor^® through AccessConnex by AccessLex^℠.