April 15th can be a day of dread for most working U.S. citizens. Nobody wants to lose a large chunk of their hard-earned money to the IRS. That’s why many people choose to buy a home. They know they can get a large tax deduction by owning real estate.
However, most taxpayers don’t know that they can get many more tax deductions by owning rental property rather than a primary residence. In fact, many real estate investors pay virtually no taxes.
You can only deduct mortgage interest on your primary residence, but with a rental property, you can deduct the mortgage interest plus repair costs, travel to the property, management, lawn care, insurance, taxes and even real estate education. You can even deduct depreciation expenses for “wear and tear,” even if the property is appreciating.
When you sell your investment property, you can avoid paying capital gains taxes by purchasing a replacement property of equal or greater value through the 1031 exchange laws.
Does it make more sense to buy investment property instead of a primary residence?
It mainly depends on where you live and how much money you make.
In high priced markets, it’s often cheaper to rent than to own property. The opposite is true in affordable markets, where it may be cheaper to own property than to rent it. The better choice is the one that cash flows the best (the one that puts — or keeps — more cash in your pocket now).
For example, the median home price in San Francisco is $595,000. The monthly mortgage payment, including taxes and insurance, would be approximately $4,500 per month with an FHA loan. However, it would cost about $3,000 per month to rent the same place. In this case, renting has the better cash flow, and would put an additional $1,500 per month in your pocket.
However, as a renter, you don’t get tax benefits, leverage or long-term capital gain from owning property. So you could spend the $595,000 you were going to pay on a primary residence, and buy rental property instead.
Where does the cash flow?
With $595,000 worth of investment property, you could receive approximately $6,000 per month in rental income if you bought in a more affordable city than San Francisco. You could use $3,000 of that cash flow to rent your primary residence in the more expensive city, and put an additional $3,000 of that rental cash flow back into your pocket.
Plus, you could enjoy far more tax deductions on the rentals than if you bought a primary residence.
You could pay down your mortgage on the rentals with the extra cash flow or invest in more property. This is how real estate investors end up with several paid-off investment properties by the time they’re ready to retire.
Set yourself up for real wealth
How would you like to collect rental income on several homes you own free & clear? This is our definition of real wealth: the ability to spend your time the way you want. The passive income streams we enjoy from real estate property helps us get there.