There are tax consequences for that little cash cow
Real estate has always been, and will continue to be, one of the very best long-term investments you can make. By definition, an investment property is real estate purchased with the intention of earning a return on the investment, either through rental income, future resale, or both. An income property is a non-owner-occupied investment property (commercial or residential) bought for the purpose of generating passive income through rental activity.
A smart investment. Passive income. Sign me up, right?
Before you start shopping for that little cash cow, you’ll need to educate yourself. Only then will you be able to decide if owning income property is a good fit for you.
- Although many factors influence whether or not a particular property is a good ‘income investment,’ those that meet the “One Percent Rule” deserve a closer look. The rule simply states that one month’s rent should equal one percent or more of the purchase price (after any necessary repairs or improvements).
- Generally speaking, you should limit your search to existing rental properties. This will enable you to verify rental history, vacancy rate, and operating costs before you buy. Also, check to make sure there is a current Certificate of Compliance on file (required by many municipalities, including the City of Columbia).
- If you lack the cash to purchase the property outright, be aware that a mortgage for a non-owner-occupied property may carry a higher interest rate than one that’s owner-occupied. Lenders see it as a greater risk.
- Beware of properties marketed as “under-rented,” meaning the market can bear a higher rental rate than that which is currently being collected. While there may be properties out there where this situation exists, they are generally under-rented for good reason! We have extensive local market knowledge and direct access to actual data to confirm or deny the seller’s claim.
- Assuming the subject property meets the One Percent Rule, you’ll still need positive cash flow after satisfying the debt load (in the case of a mortgage) and operating expenses. If you don’t have the time or skills to manage the property, budget for the services of a property manager. Be aware that tenant emergency calls rarely come at convenient times!
- Get sound professional advice upfront. An accountant can advise you with respect to the tax consequences of owning the property as an individual versus a legal entity, as well as recommend strategies for managing cash flow, deposits, etc. Hire an attorney to prepare (or at least review) the lease agreement and other tenancy documents you intend to use. It’s important to understand your rights, but also the rights of your tenants.
- Give serious consideration to the length of time you plan on holding the property. Unlike the stock market, real estate transactions involve significant transaction costs (as a percentage of market value). Selling and buying property too frequently undermines your return.