Rental Property

 

Any multi-family commercial apartment, privately owned homes, a portion of the home you occupy, is deemed a rental if you let it out for a monthly payment to people to stay in. Rentals can be commercial (where the tenant conducts a business) or residential (where the tenant resides).

Housing costs are out of reach of many people such as the newly married, students and even single persons, so rentals are a viable option. Hence rental housing is an excellent investment option for the average person.

Before an owner decides to allow rentals in his property he has to acquire a rental safety certification that indicates that the property is safe for tenants. This certificate which is issued by the state authorities is preceded by an inspection of the premises by the state housing inspectors. Once the rental passes inspection and obtains a certification, is the time to advertise for tenants. The most important part of a rental is tenants; hence screen applicants by requiring them to fill a rental application. A detailed rental application gives you important information on the tenant's background, ability to pay, a permanent address, and occupation and employment details. Information on number of members, pets and such should be provided. Once an applicant passes muster, the prospective tenant signs a Residential Lease. A Residential Lease protects the owners and tenants rights. It is a document that lays down the terms and obligations that you require the tenant to abide by and also the rights due to a tenant, the rent agreed upon, the deposit required and future percentage of increase in the rent, all these matters are specified.

A Residential lease legally protects you and your property.

Rental property Tax Benefits :

The most positive aspect of renting is that you can retain ownership of the property, while at the same time earning an income from it. All income that generates from a rental is subject to tax and must be shown to the Internal Revenue Service (IRS). Expenses incurred on the property such, as repairs are deductible.

Tax benefits are afforded to the owner on rental property and some tax benefits are:

  • Mortgage Interest : the interest you pay on your rental property mortgage is deductible from your taxable income.
  • Depreciation : The cost of the rental real estate can be recovered through depreciation which is claimed as a deductible expense for 27.5 years. But you can avail this benefit from the second year of ownership.
  • Repairs : Expenses incurred on repairs are deductible, from taxable income. Repairs such as painting, help keep the property in good condition, but do not add to the value of the property.
  • Travel expense : Expense that you incur while traveling for rental related work is also tax-deductible.
  • Home Office : If some part of your home is used as an office for rental management, then expenses incurred can be deducted from your tax.
  • Salaries paid to employees and contractor fees : This is also a deducted from your tax if you employ a rental property manager and fees paid to a contractor who undertakes repairs on the rental property.
  • Insurance : All premiums paid on any insurance can be treated as a tax deductible.
  • Legal and professional fees : Fees paid to attorneys, real estate investment advisors, accountants and managers are all part of deductible income.

One benefit of rental property is that the initial investment is not large; the property can be purchased with a small down payment. Once you rent out the property, the rental payments from the tenant pay off the mortgage and positive cash flow is maintained through tax deductions and depreciation. Some factors are to be taken into account when investing in rental property.

 

  • Location : The area in which your rental property is situated plays a major role in the income generated and the type of tenants you will attract. Choose an area near your residence or in a good rental area.
  • The principle of no surety must be maintained. You should have good equity to ensure a above average cash flow.
  • Be sure to have enough funds to tide over when the rental property is vacant.
  • Your balance of funds must also be able to cover maintenance and improvement costs.
  • You must provide a fair deal to the tenants while making a profit for yourself.

Advantages of Rental Properties :

Rental Property offers advantages that are not obtained in other forms of investment. The main advantage is that you retain ownership while earning an income from your rental property.

Some other benefits are :

  • Leveraging your investment in the rental property.
  • Rental property income creates a positive cash flow.
  • A small or at times no saving to get started.
  • Tax advantages.

Leveraging your investment : A person interested in buying a rental property as an investment can do so with a small down payment of say 20%. This modest investment gives you control over an income generating asset. The rental property appreciates over a period of time thereby increasing your investment. Once you rent out the property the tenant pay off the mortgage with their monthly rents.

Suppose you purchase a rental property valued at $150,000 with a down payment of $30,000. Suppose you sell the property after 5 years for $165,000 for a net profit of $15,000. The rental property appreciated by a modest 10% over the 5-year period. However your investment return on the initial payment is 50%, all due to the fact that you leveraged your initial investment.

Positive Cash flow : Positive cash flow is excess of rental income after expenses are paid. For instance the above mentioned rental property generates a rent of $800 per month. Taxes, insurance, possible repairs, maintenance, vacancy reserve cost $200 per month. Monthly mortgage payments are $550 per month. The positive monthly cash flow is $50.

This monthly cash flow increases over time as mortgage payments keep reducing and rents increase. If you hold on to your rental property till the mortgage is paid off, then cash flow is greatly enhanced.

Tax benefits : All rental properties attract tax deductions that can translate into an increase in the cash flow.

Some drawbacks of rental properties :

  • Tenants can be a problem, if they do not pay on time, damage the property or refuse to vacate. Legal costs to deal with difficult tenants can offset whatever benefit you incur.
  • Your temperament should be suited to become a landlord or else you then need to hire a property manager. This is an additional expense that reduces your cash flow.