Various Ways to Invest in Residential Income Property: Various Ways to Invest in Residential Income Property. The first (and one of the best) real estate investments for many people is a home in which to live.

Various Ways to Invest in Residential Income Property

 Gordon van Eeden

Various Ways to Invest in Residential Income Property

The first (and one of the best) real estate investments for many people is a home in which to live. In this section, we cover the investment possibilities inherent in buying a home for your own use, including potential profit to be
had from converting your home to a rental or fixing it up and selling it. We also give you some pointers on how to profit from owning your own vacation home.

Buying a place of your own

During your adult life, you’re going to need a roof over your head for many decades. And real estate is the only investment that you can live in or rent out to produce income. A stock, bond, or mutual fund doesn’t work too well
as a roof over your head!

Unless you expect to move within the next few years, buying a place probably makes a good long-term financial sense. (Even if you need to relocate, you may decide to continue owning the property and use it as a rental property.)
Owning usually costs less than renting over the long haul and allows you to build equity (the difference between market value and mortgage loans against the property) in an asset.

Under current tax law, you can also pocket substantial tax-free profits when you sell your home for more than you originally paid plus the money you sunk into improvements during your ownership. Specifically, single taxpayers
can realize up to a $250,000 tax-free capital gain; married couples filing jointly get up to $500,000.

In order to qualify for this homeowner’s gains tax exemption, you (or your spouse if you’re married) must have owned the home and used it as your primary residence for a minimum of 24 months out of the past 60 months. The 24 months doesn’t have to be continuous. Additionally, the IRS now provides for pro-rata (proportionate) credit based on hardship or change of employment. Also, note that the full exemption amounts are reduced proportionately for the length of time you rented out your home over the five-year period referenced above.

Some commentators have stated that your home isn’t an investment, because you’re not renting it out. We respectfully disagree: Consider the fact that many people move to a less costly home when they retire (because it’s
smaller and/or because it’s in a lower-cost area). Trading down to a lower-priced property in retirement frees up equity that has built up over many years of homeownership.

This money can be used to supplement your retirement income and for any other purpose, your heart desires. Your home is an investment because it can appreciate in value over the years, and you can use that money toward your financial or personal goals.

Converting your home to a rental

Various Ways to Invest in Residential Income Property

Turning your current home into a rental property when you move is a simple way to buy and own more properties. This approach is an option if you’re already considering investing in real estate (either now or in the future), and you can afford to own two properties. Holding onto your current home when you’re buying a new one is more advisable if you’re moving within the same area so that you’re close by to manage the property.

This approach presents a number of positives:

1. You save the time and cost of finding a separate rental property, not to mention the associated transaction costs.
2. You know the property and have probably taken good care of it and perhaps made some improvements.
3. You know the target market because the house appealed to you.

Some people unfortunately make the mistake of holding onto their current home for the wrong reasons when they buy another. This situation often happens when homeowners must sell their homes in a depressed market.
Nobody likes to lose money and sell their home for less than they paid for it. Thus, some owners hold onto their homes until prices recover.

If you plan to move and want to keep your current home as a long-term investment (rental) property, you can. If you fully convert your home to the rental property and use it that way for years before selling it, after you do sell you can either take advantage of the lower long-term capital gains rates or do a tax-deferred exchange.
For tax purposes, you get to deduct depreciation and all of the write-offs during the ownership and you can shelter up to $25,000 in income from active sources subject to income eligibility requirements.

Turning your home into a short-term rental, however, is usually a bad move because:

– You may not want the responsibilities of being a landlord, yet you force yourself into the landlord business when you convert your home into a rental.
– You owe tax on the sales’ profit if your property is classified for tax purposes as a rental when you sell it and don’t buy another rental property.

Effective tax year 2009, you lose some of the capital gains tax exclusion if you sell your home and you had rented it out for a portion of the five year period prior to selling it. For example, if you rent your home for two of the last five years, you may only exclude 60 percent of your gain (up to the maximums of $250,000 for single taxpayers and $500,000 for married couples filing jointly), whereas the other 40 percent is taxed as a long-term capital gain.
Also, be aware that when you sell a home previously rented and are accounting for the sale on your tax return, you have to recapture the depreciation taken during the rental period.