September 1, 2017
Thinking about acquiring a rental property? Before you dip your toes into the world of rental real estate and property management, it’s important to first ask yourself several important questions. Here’s a quick list to help get you started:
Have You Conducted a Cash Flow Analysis?
Cash flow analysis is critical — it will help you determine if the moment is right to buy and if you can afford it. You’ll have to balance the rental income you bring in with ongoing expenses such as mortgage payments, property taxes, insurance, repairs, property management fees, and don’t forget your down payment! Down payments can be anywhere between 20-30 percent of the purchase price, depending on the type of home. What will happen to your cash flow if a tenant leaves and you can’t fill your rental right away?
Real Estate or Cash – Which is More Important?
Be honest with yourself about your cash flow accessibility! “We recommend six months to a year of cash reserves to buy property, including a rental property. It’s a general rule of thumb in case someone sustains a job loss or a change in their day-to-day financial situation,” explained Javier Padilla, CPA, licensed real estate broker, and Experienced Senior Associate at Grimbleby Coleman.
Have a Plan for Property Management?
Do you plan to outsource to a property manager or manage the property yourself? This is a key component to consider. Are you a do-it-yourself person who enjoys undertaking repairs, or do you foresee contracting labor to an outside source? Know your capabilities and options! You’ll also want to consider whether you want to deal with the tenants one-on-one. Do you have the heart and personality to enforce difficult decisions, such as serving eviction notices? If not, you may want to invest in a property management service. Trying to save money by doing it yourself could end up costing you both money and sleep.
Make Too Much and a Rental Loss Doesn’t Matter!
Real estate is a long-term investment and can be profitable with the right property. Real estate losses are normally deductible, but that deduction evaporates when you reach $150,000 in adjusted gross income. In that case, rental losses get “trapped” for that year and can only be used in a profitable year or when you sell the property.
Designation as a Real Estate Professional
You can get around the trap mentioned above if you designate yourself as a real estate professional, but that designation takes work — over 500 hours per year. You can earn those hours by working on the rentals or selling real estate. You must keep detailed records if you decide to become a real estate professional; the burden of proof is on you.
Repairs – Expense/Deduct in the Current Year or Capitalize?
Some big expenses — such as a new roof or air conditioner — will need to be capitalized, which means you won’t be able to deduct them in the current year. Lawn maintenance, garbage disposal, plumbing repairs, and other small repair costs may be deducted in the current year. Keep in mind: this only applies to rentals!
Rental properties can be risky and they’re not for everyone. However, it might be worth the effort in the long run if you’re an investor with vision and have an appetite for risk. If you have any questions about how a rental property could impact your tax planning or finances, please reach out — we are always here to help! Contact Javier or at 209-527-4220.