2 Simple Ways to Identify a Bargain From Your Real Estate Investment

Most people spend their time wondering when the real estate market is good to enter and purchase real estate based on some friend’s recommendations. Others are more emotional and buy real estate on their whim and fancy. Such ideas may work sometimes but are not very reliable indicators on when to enter and exit the real estate market. Thus this article highlights a 2 step process to analyze your real estate investments.

Firstly, in real estate investing, just like in the stock market, there is readily available public data, which you can chart to determine if the real estate boom or bust is bottoming out. Like in any investment, try to purchase the instrument at the bottom of a cycle so that you gain on the rebound. Similarly take the rental yield cycle into consideration when you do your maths to determine whether the property is worth acquiring since you want to ensure that you have enough monthly rental to cover your mortgage installments even in the leanest of rental periods.

The best way to analyze this real estate investment analysis is to look at charts and data with regards to the relevant data. You want to look and examine in which part of the real estate cycle, your prospective real estate property lies in and how the rentals are doing in your potential real estate investment. Thus after this analysis, you will know where the pricing of your real estate investment is heading and plan accordingly.

Secondly, after analyzing statistical data, go down to a real estate agents office and talk to them and ask them about their outlook for the real estate investment sector that you are interested in investing in and ask them for indicators of good rental yield in terms of location and whether any events or developments would help to increase rental yields in an area. If for instance they know that a new business district is slated for development next to your prospective purchase, you want to know that too as it would mean a huge jump in price of acquisition and rental yields and a huge gain in your real estate investment.

Always spend some time planning what information you want to get out of the real estate agent before you go down and always know what type of real estate investment property so that you can save his and your time when you view properties. After a while you will get a rough sense of the property prices in an area and when you see a bargain property investment you will know it’s the right one for you.

In conclusion, we have highlighted two ways to identify a bargain from your real estate investment in this article. Spend some time this week looking at your next real estate investment deal and perhaps it might turn out to be a bargain.

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An In Depth Look At Real Estate Transactions

I don’t know what percentage of American financial portfolio’s contain real estate, but my guess is many. Properties will likely range from principal residences, to second homes and rental properties. There can also be the instance where multiple properties are owned in a given portfolio giving rise to what is known as the qualified real estate professional. Please take the time to review this article carefully, ponder its message, and incorporate it into the most valued and sacred set of financial plans, past, current, and future; your own.

Let’s begin with the principal residence. Ask any American walking about what advantages exist through home ownership and they will respond with; “it is a great investment”, and “it will provide income tax breaks”. Yes indeed, the principal residence is an asset in anyone’s estate and it will provide income tax breaks through mortgage interest deductions and real estate taxes. Believe it or not, the knowledge necessary for home ownership does not end with these two basic considerations. Selling the principal residence has income tax consequences. What if there is a home office taking up part of the space within the principal residence? What happens with improvements made over time? What happens when the homeowner passes to the next life? As is always the case in our culture, there’s more to a situation than meets the eye. Knowing the rules of the game and keeping careful records will lead to significant financial gain through tax savings.

The basics of home ownership mean that we will get a home mortgage interest tax deduction. There will also be a deduction for real estate taxes paid. The limit for deductibility of home mortgage interest expense is $1,000,000 of original acquisition. There is also allowed a home equity line of up to $100,000. In addition to the principal residence, a taxpayer can deduct mortgage interest expense on a second home of his choice. The $1,000,000 acquisition limit includes both the principal residence and the second home. An example would be that a given taxpayer purchases a principal residence and takes out a mortgage of $500,000. This same taxpayer purchases a second home with a mortgage of $400,000. Because the sum of the mortgages is less than a million dollars, this taxpayer will be able to deduct the mortgage interest expense on both properties as qualified home mortgage interest.

If the mortgages had totaled $1,100,000, the taxpayer would still be able to take interest on both properties in full by using the original acquisition limit plus the home equity loan limitation of $100,000. If the sum of these to mortgages happened to sum to $2,200,000, the taxpayer would be limited to deducting 50% of mortgage interest paid based on the following ratio: $1,100,000/$2,200,000. My guess is that many of you are thinking so what. My mortgage or mortgages are far under the appropriate thresholds. Let’s review for a moment what happens when one decides to refinance the principal residence. What if a home was purchased in 2001? In 2006, the homeowner refinances and takes money out of the property for assorted reasons. If the home purchase was for $200,000 with a $150,000 mortgage back in 2001, let’s assume that the refinance amount was for $400,000 in 2006, where the original mortgage amount was paid down to $140,000. The taxpayer’s new mortgage is now $400,000. Will there be a tax deduction under qualified mortgage interest rules for the entire mortgage amount? A taxpayer is limited to the original acquisition mortgage plus the $100,000 home equity loan.

In our example, the taxpayer would be able to deduct mortgage interest up to $250,000 of mortgage. The ratio for mortgage interest deductibility would be $250,000/$400,000. The remaining balance of mortgage interest expense could be deductible under other areas of the tax return subject to the interest tracing rules. If some of the loan proceed were invested in the stock market, this would give rise to investment interest deductions subject to that set of limitations. If loan proceeds were used to start a new business, the mortgage interest expense would be deductible as trade or business expense. To the extent the home owner makes improvements to his principal residence, the original mortgage acquisition amount is increased. In this example, if the taxpayer made home improvements totaling $150,000 or more, the entire mortgage of $400,000 would yield mortgage interest expense that would be totally deductible as qualified home mortgage interest expense. I don’t know about everyone else, but his fascinates the life right out of me. It should shine a new light on mortgage interest expense and it related deductibility.

In so far as thinking of one’s home as an investment, there will be many school’s of thought dealing with the principal residence. One thought is that if one sells a home, there will be need to acquire another one. The idea here is that proceeds from the sale of the residence will not be used in any other way aside from a new home acquisition. The home is an asset regardless of its view as an investment, but keep in mind that there are taxpayers who actually by down in a new residence. They may even change its location to an entirely new environment such as a different location in the country where the standard of living is less expensive. Why is this important? Remember the old rules for dealing with gain on the sale of one’s principal residence? There once was a time when a taxpayer had to purchase a new home that was greater or equal to the value of the one sold. This was old code section 1034. The gain would be rolled into the cost basis of the new home acquired.

When a taxpayer reached the age of 55, he could make a once in a lifetime election to permanently exclude gain not exceeding $125,000 from income tax. The current rules are entirely different. There is no longer a requirement to purchase a new principal residence. In addition, the gain exclusion increases to $250,000 for individuals and $500,000 for married couples filing a joint income tax return. The once in a lifetime requirement of old code section 121 has also been eliminated. Now the aforementioned exclusions will apply in unlimited fashion as long as the following requirements are met. The home must be a principal residence for 2 years out of a 5 year period. The 2 years need not be consecutive. There can be only one sale of a principal residence in a 2 year period. There is more opportunity to have the principal residence be counted under the investment column of one’s portfolio thanks to the new tax law regarding this area.

With the advent of new code section 121 and the permanent repealing of code section 1034, it still becomes necessary to track one’s basis in a principal over time. The original cost of the home is easy. To this original cost, the taxpayer should keep record of all improvements made to the dwelling. This will include roof repairs, swimming pools, new windows, landscaping, and much more. In addition to tracking improvements, there may also be the need to track fair market value step-ups. Suppose that husband and wife purchase a home in 1990 for $200,000. For a ten year period, husband and wife made $100,000 in improvements. In 2005, wife passes away when the home’s fair market value is $800,000. During 2006, husband meets a hot young woman and decides to take up residence at the beach (I thought this might add some spice to the story).

He is going to sell the residence in 2007 or 2008. What is his exposure to gain? Well, the original cost basis of the home plus improvements is $300,000 of which husband will get half or $150,000. He then gets a step-up of $400,000 from wife’s share of the residence. Husband’s total basis in the principal residence is then $550,000. If he sells the residence in 2007 for $800,000, he will have no taxable gain as the selling price less his basis and $250,000 exclusion (for being a single homeowner) equals zero. Knowing the rules is essential. As an aside, if husband sells the home if 2005, in the year of wife’s death, he will not only get a step-up in his basis for wife’s one half basis, he will also get the full $500,000 gain exclusion under code section 121. After the year of death, a surviving spouse will only get $250,000 in gain exclusion.

Rental Properties

Real estate also takes form of rental or investment property in a portfolio. If a taxpayer is gainfully employed in another line of work, the rental properties will take on an investment role. Let’s have a quick review of the rules governing rental real estate in the world of income tax. Rental activity is defined as being passive. For income tax purposes, passive income is netted with passive losses. If passive losses exceed passive income, this loss is suspended and carried over either to be offset with other future sources of passive income or to be realized when the activity generating the losses is sold or terminated. There is a special rule for those owning rental properties where they maintain active participation in the activity. Active participation is defined as having the obligation or right to make decisions regarding the activity. This qualification is easily met as the property owner must make decisions regarding property repairs, rent levels or increases, and the like.

When the taxpayer meets the active participation requirement, he then will receive benefit of losses from the property so long as they do not exceed $25,000. In addition, the taxpayer will lose benefits of these losses as adjusted gross income exceeds $100,000. The $25,000 loss limit is phased out 50 cents for each dollar that adjusted gross income exceeds $100,000. If a taxpayer has adjusted gross income of $125,000 before rental activities, the loss limit is reduced to $12,500. If losses from rental activities are $15,000, the taxpayer will get to deduct $12,500 currently and will carry over the remaining $2,500. If adjusted gross income is $150,000 or more, losses will not be currently deductible unless there is income from passive activities. Here is another point where knowing the rules will be a huge benefit. Adjusted gross income in excess of the $150,000 limit does not have to eliminate the ability to gain income tax benefits. Earlier, there was mention that passive income will net with passive losses. If a taxpayer could receive passive income from other sources, he could use passive losses to offset it regardless of his adjusted gross income level. Passive income can be generated by investing funds in real estate ventures that pay returns on the investment. An example would be an organization like AEI that puts together real estate deals that are economically sound and will generate, and pay out, this passive activity income. This could make for a sound development of one’s portfolio while taking advantage of income tax attributes at the same time. Passive losses suspended from previous years, as well as those generated currently and in the future, can offer income tax advantages when netted against passive income.

What about the qualified real estate professional? They are not subject to passive activity limitations nor are they subject to the rules of active participation. If a taxpayer is able to demonstrate that he spends as much time performing real estate functions as he does other activities, he has met level one of the test. He must also demonstrate that he spends at least 750 hours a year on real estate related functions. This is roughly equivalent to 15 hours per week and must be met by either the taxpayer or his spouse, but not combined. When the classification of qualified real estate professional is reached, a mountain of other issues and considerations will arise. This will be beyond the scope of this article but as always, there is a standing invitation to be in attendance for the “most complete business program on radio”.