Is it time to invest in a rental property?

Low home prices and near record low interest rates have spurred many borrowers to consider making an investment in rental property. But does this make sense for you? While there is always potential to make a profit through the ownership of rental property whether it’s through the appreciation of the property or through monthly rent (cash flow), the key factor is buying smart. You should know when to buy, how much you can qualify for, how to determine the current market value of a property, and most importantly get pre-approved before submitting offers. Here are some key areas of consideration and tips when choosing to buy investment/rental property:

Market Timing

Real estate markets and interest rates are both extremely cyclical, and these cycles have a direct and important effect on your ability to make a profit. You are less likely to profit if you are buying a property that’s priced high or is over-valued while at the same time interest rates are high. If the return on your investment is based on appreciation (and not necessarily rental income), you may be tied to this property for longer than you expected to be if you buy during a seller’s market. So, before deciding to purchase, you need to consider your exit strategy based on best and worst case scenarios. This is important even if the property is to be held for long-term appreciation.

Bargain Homes

With 28% of homes still underwater, there are likely to be plenty of bargain opportunities that can provide cash flow as rentals and appreciate when the market turns around. Bargains are found by purchasing properties through a short sale or foreclosure, probate properties, sellers who are facing divorce and bankruptcy, and FSBO (for sale by owner) properties.However, keep in mind that bargain prices do not always equal good investments! A run-down house in a declining neighborhood may be cheap to buy, but if you are looking for cash flow, you need to consider tenant stability in the neighborhood as well as your own experience with working with tenants. In a declining neighborhood, you may want to consider working with a local property manager who may better know how to vet potential renters as well as what the laws are associated with tenant issues should they arise. It may be better to pay a little more for homes in solid neighborhoods with low crime rates and neighbors who show pride of ownership. Location can also be important to potential renters who may need access to public transportation, shopping malls, schools, business centers, or other amenities. The more you have to offer, the more likely you are to attract the right kind of tenant. This will also pay dividends to potential buyers if you decide to sell your home at a later date.

Investment Strategy

Purchasing a property for investment should be done within the confines of your overall investment strategy/portfolio. In addition, how you manage the property is important. Do you need a longer-term investment where cash flow doesn’t matter? Do you have the resources to flip a property to make short-term profits? Or do you simply need cash flow? As a tip, properties purchased for long-term appreciation should be held in a separate company from properties that will be sold in under a year to avoid issues with the IRS.You should also verify, perhaps with your financial advisor or planner, whether you have enough assets to handle the ups and downs that could come with investing in a rental property. Any time your rental property remains vacant, you will still have to pay for the mortgage. A good rule of thumb is to ensure enough asset reserves for covering up to six months of mortgage payments. Even if you never have to use these funds, it is there if you need it, and you can also use the money for unexpected repairs. If you plan to fix up and sell the home for a profit, this financial cushion could also be tapped in the event that you must hold onto the property for several additional months due to varying real estate market conditions.

Your Buying Power

Once you have determined your strategy and timing, before you can shop, you should know how much buying power you have. Work with your loan officer to understand what considerations are important before starting a property search. Once you find that property you wish to purchase, a pre-approval is a necessity in this market if you are not using all cash to purchase the property. Many real estate agents will ask for a pre-approval letter upfront, to show that you can qualify for the purchase of the property. Feel free to contact your loan officer with any questions regarding rental properties or to obtain a pre-approval!

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As home prices fall further, is it time to buy?

It's not too late to use these tax tips!

We are well past the tax year-end of December 31st, and the tax filing deadline (April 17th this year) is right around the corner, but there are still ways to minimize your tax burden. Read on to make sure you are taking advantage of your options.

1. Retirement Contributions

You have until April 17th to make a Traditional IRA or Roth IRA contribution for 2011. Depending upon your employer retirement plans, you may even be eligible to deduct your Traditional IRA contribution.

2. Deductions

Organize your expenses. While expenses you incur after year-end can’t be used for this upcoming filing, if you organize your 2011 expenses, chances are you will uncover some deductions you weren’t aware of. And if you use the standard deduction of $5,800 for singles or $11,600 for married couples you may find you get more bang for your buck by itemizing. There are the common deductions most taxpayers know about like home mortgage interest, but there are more obscure ones to be aware of, like miscellaneous deductions and medical deductions. Miscellaneous deductions, which includes things like tax preparation fees, investment management fees, job-hunting expenses and professional association dues can be deducted to the extent they exceed 2% of your Adjusted Gross Income (AGI). Medical expenses can also be deducted to the extent they exceed 7.5% of your AGI.

3. Any IRA Distribution (other than a Roth IRA)

If you have made $5,000 in non-deductible contributions to your retirement accounts, the assets grow to $6,000 and you withdraw the entire amount, only $1,000 is taxable. Many people overlook this because the tax form from the custodian shows a $6,000 withdrawal. Be sure to account for any “basis” in your retirement account withdrawals on your tax return since that portion should not be taxed.

4. Required Minimum Distributions

The IRS requires that you take Required Minimum Distributions (RMD) from retirement accounts starting in the year you turn 70 ½. If you reached age 70 ½ in 2011 and didn’t take your RMD, you’re in luck because you can still take it by April 1st, which is the grace period allowed for your first RMD only. If you miss the deadline, the IRS imposes a 50% penalty on the amount you should have withdrawn. Ouch!

5. Heed the Rules

The IRS doesn’t like when taxpayers don’t play by their rules. If a taxpayer doesn’t file a return or extension by April 17th a penalty of 5% of the tax due is imposed every month up to 25%. If the taxpayer doesn’t pay the tax, there is a penalty of 0.5% of the tax due every month up to 25% plus interest. If the taxpayer is just lazy and negligent in preparing their return, a 20% “accuracy” penalty of the tax due is imposed. And fraud? Well, aside from the possibility of wearing a zebra suit the IRS slaps offenders with a 75% penalty. Fortunately, avoiding these penalties and interest is in your control and there is still time to avoid it all.

6. Investment Property

If you purchased investment property in 2011 and are new to such a venture it pays to organize your records and be aware of the tax treatment of related activity, such as:

• To qualify as an investment property your personal use of the property cannot exceed the greater of 14 days or 10% of the days the property is rented during the year. For instance, if the property was rented for 300 days of the year, your personal use can be up to 10% or 30 days without jeopardizing the investment property status.

• Rental income is taxable in the year received, not the year the rent applies to.

• Security deposits are not taxable, although any amount you do not return due to property damage is.

• You can generally deduct any costs incurred to get the property ready to rent and those to maintain it, such as advertising, cleaning, repairs, homeowner’s dues, insurance, management fees, supplies, utilities, yard maintenance and any travel to the property if that is the primary purpose of the travel. If the primary purpose of the travel is other than the property you are limited to deducting the portion of your travel dedicated to the property.

• While repairs are deductible, improvements are not, but can be capitalized and depreciated. Examples of improvements are putting in a new patio or upgrading a kitchen.

• Investment property is considered a passive activity. In short, this means that your property losses can only offset property income and not earned income from a job. An exception to this comes into play if you own 10% or more of the property and make the major decisions about the property, in which case you can offset other income up to $25,000. This benefit does however phase out between $100,000 and $150,000 of Modified Adjusted Gross Income.

If you’ve gotten his far, you hopefully found one or two things that will keep an extra buck or two in your pocket this tax season, which we hope is a painless one for you!

Contributed by Kevin Mahoney, CFP^®, Integris Wealth Management