Title: Diversifying Through Real Estate
Author: Chris Cooper
We should all diversify our investments over different asset
classes. Real estate is an excellent vehicle for diversification.
Real estate rental properties used to be a perfect investment
for high wage earners. They were able to deduct all the losses
generated by the property - and when you added up mortgage
payments, property taxes and maintenance, the losses could be
substantial - from their gross incomes.
The IRS has rained on that parade. Real estate rental properties
are now considered passive activity, even if you actively manage
the property. The only ones who can take full advantage of real
estate investing losses these days are the so-called "real
However all is not lost. Even now you can deduct all the
expenses of a rental from the gross rental income. If the losses
exceed income, they are converted into passive activity losses
which are not deductible against ordinary income, but are
deductible against other passive activity income as well as any
gain made when the property is sold.
Real estate investing offers several special advantages: the
purchase can be highly leveraged, from zero down to the usual
20% down payment; the mortgage payments are generally tax
deductible as are the taxes and expenses of maintaining the
property; and if you own the property over a year, it is subject
to long-term capital gains taxes - presently 15% - minus any
accumulated passive activity losses.
Because of the highly leveraged nature of most real estate
purchases, investors can afford to own multiple properties. Or
you can start small, with one property, and use that as leverage
on another house as your equity in grows.
However, real estate is unlike other investments. Unless you buy
raw land, it requires management and maintenance, insurance and
tax payments. There will even be continuing costs with raw land,
property taxes and liability insurance being the major expenses.
If you think you can't be sued if someone trips on a log or
falls into a hole on an undeveloped piece of property, think
again. Ask your lawyer what the liability laws in your state are.
If you own rental buildings, they must be insured, properly
maintained and rented out. Someone has to fix the problems and
collect the rent. You can do this yourself, especially if you
like being awakened at three in the morning because a toilet
won't flush - I've been there and done that. Or you can hire a
management company to do this for you. Most work on a cost plus
Because of all of this, you do need to find properties that
either throw off good income from rents or have the potential
for appreciation, especially if some repairs are done. In other
words, you have to work out beforehand how any given piece of
real estate will make money for you. If it won't, keep looking.
Real estate prices are not as volatile as the stock market's can
be, but they do fluctuate. It is better to go into a real estate
investment with a long term frame of mind and remember the rule
"location, location, location".
Over time real estate values tend to grow and, because of the
leveraged nature of the investment, the growth is magnified. For
example, 5% growth on $150,000 is $7500. But if you only have
20% down or $30,000 invested, that $7500 becomes a 25% return on
Of course you don't have to own real estate outright. You can
invest in "Real Estate Investment Trusts (REIT)". These are
professionally managed funds that usually invest in larger,
commercial projects - shopping malls and office buildings. Your
aim is long term capital appreciation. The investments are
heavily leveraged and the tax benefits spread among the
Since real estate does not necessarily move in the same
directions as stocks or bonds and also generally tends to hold
its value, this is a good diversification move, but you are
unlikely to realize the gains you would see with individual real
Also, despite the fact that real estate is booming right now, it
can and has fallen, sharply at times. There have been gluts of
office space in major cities, overdevelopment of residential
housing (remember the S&L debacle of about 15 years ago), or
there could just be a general down real estate market from time
Most of us have already diversified into real estate by
purchasing our home. If the equity is preserved, this can turn
into a major cash cow after several decades of use. If certain
simple rules are met, you can exclude $250,000 ($500,000 if
married and filing separately) of any gains you realize.
As you can see, real estate investing, if done properly, can be
quite lucrative. But study the subject intensively before
committing yourself. The library is full of good books on the
Also consult with a CPA or tax attorney on how to best structure
your business for maximum returns.
For those looking for multiple streams of income, rental real
estate is a good place to start.
For more financial planning articles, visit <A
About the author:
Chris Cooper a retired attorney, and his wife Aileen, who has a
MBA in Finance, provide personal finance and financial planning
advice at <a href=" http://www.credit-yourself.com">Credit