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Tax Tips for Real Estate Investors Using IRA Funds

You’ve seen the advertisements and news articles. IRA funds can be used to make real estate investments. But before you jump on this bandwagon, make sure you understand some of the tax planning angles related to this opportunity.

Passive Loss Deductions

Almost always, an important component of your real estate profits comes from the tax savings associated with depreciation. These paper losses, referred to as passive losses by the Internal Revenue Code, can save both small and professional real estate investors thousands of dollars a year in income taxes. Unfortunately, passive losses from depreciation and related, similar tax deductions won’t benefit real estate investors investing through IRAs.

Capital Gains Preferences

If you sell an investment for a profit—whether a stock or real estate—you get a tax break because your profit gets taxed at a preferential capital gains tax rate. In the best case scenario under current tax law, for example, your capital gains get taxed at 15% rather than at 35%.

Unfortunately, by putting real estate inside of an IRA, you lose this benefit. In effect, the appreciation you enjoy from your real estate investment gets taxed at your marginal income tax rate rather than at the capital gains rate. (Fortunately, the tax gets paid when you withdraw the money.)

Note: This “problem” also exists for other investments that produce capital gains, such as stocks and mutual funds that invest in stocks.

Unrelated Business Income Tax

In certain special circumstances, an IRA needs to pay income taxes on the profits it generates. These taxes, called unrelated business income taxes, essentially put the IRA investor in the same position as a regular taxable investor.

For example, if you’re developing and then flipping properties inside your IRA, you may actually be an active trade or business. And in this case, your real estate investment—even though it’s inside an IRA—may be subject to income taxes. (Your IRA custodian is supposed to report your taxable income and tax liability, and then pay the taxes but many don’t…)

And here’s another example of a situation where the unrelated business income tax can trip you up. If you borrow money to invest in real estate—the typical situation in any leveraged real estate investment—the profit you earn on the money you’ve borrowed is treated as unrelated business income. Accordingly, that profit is subject to unrelated business income tax.

Unrelated business income inside an IRA is taxed according to trust taxation rules, which means that as soon as you’ve made much money at all, you’re taxed at the highest marginal tax rates. Ouch.

Closing Caveats

Real estate is a great investment. And real estate belongs in any investor’s portfolio. But you need to think carefully about buying into the idea of using your IRA to make real estate investments. If you do decide to invest in real estate through your IRA, first consult with your tax advisor.

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About Rental Insurance

Many renters don’t stop to think about what happens if there is a fire, someone breaks in and steals their new TV or stereo, or a visitor slips and falls on their property. The sad truth is; you will be responsible! While your landlord has insurance that covers the actual building, that coverage does not include your personal property or liability for injuries which occur in the space you rent ~ be it an apartment or a house and yard.

If a fire should destroy or damage your home, your landlord’s insurance will cover the structure. It won’t cover damage or loss of your belongings. Neither will it provide for the cost of temporary housing for you and your family.

You may think you don’t own enough personal property to make the cost of insurance worthwhile. You’re probably wrong! If you sit down and add up the cost of everything you own, you may be in for a big surprise. Consider what you have invested in such things as:

• Furniture and accessories • Electronics like TV, stereo, computers • Small appliances like microwaves, toaster ovens, etc. • Clothing • Art work like paintings or prints • Dishes, silverware and cookware • Sporting equipment • Books • Jewelry

Could you afford to replace all of these things?

Even worse, what would you do if a friend is injured on your property and decides to sue you for medical costs and more? It’s a scary thought, isn’t it?

Are you beginning to see why rental insurance may be a very wise investment?

The cost of rental insurance is based on several factors:

• The dollar amount of your coverage

• Deductibles

• Whether you choose to be reimbursed for Actual Cash Value or Replacement Costs (more about that in a minute)

• Where your rental property is located and the number of previous claims made, not only by you, but by others living in the same area.

Let me explain the difference between Actual Cash Value (ACV) and Replacement Costs. ACV is the value of your property at the time a loss takes place. For example, if your television set is five years old, it’s valued at much less than if it were brand new. The lesser amount is what you are reimbursed.

However, if you opt for Replacement Cost, you’re paid whatever it costs to go out and buy a new TV with similar features. Insuring for replacement cost raises the amount of your premium so it’s a good idea to get quotes for both ACV and Replacement Cost policies. Then you can decide which option fits your needs and budget.

Another thing to keep in mind is that jewelry, valuable collections, and guns are usually covered under a separate policy or “rider”. If you own these kinds of items, be sure to tell your insurance agent. You don’t want to find out after disaster strikes that they aren’t covered or that they aren’t covered for their true value. One way you can reduce the cost of your rental insurance is to check with whichever company insures your car. If they provide rental insurance you may be eligible for a multi-line discount.

Rental insurance may be worth the investment just for the peace of mind it offers you.

5 Tips for Overseas Vacation Home Buying Success

The dream of owning a vacation home in some sun-drenched overseas location is one the majority of us share, and because real estate proves itself time and again as a solid long-term investment commodity, many more people are committing to purchasing real estate abroad as an investment that they and their family can also enjoy and benefit from.

When buying a vacation home abroad there are a number of key considerations to bear in mind to avoid some of the traps and pitfalls sometimes associated with buying long distance and in an unfamiliar country.  With these 5 tips for overseas vacation home buying success you can quickly cut a swathe through the research process and move towards securing the dream swiftly and securely.

Tip One – Learn the Rules and Regulations

Different countries have different rules relating to the right or otherwise of foreign citizens to own the freehold title to immovable property.  Some widely publicised destinations don’t allow foreigners to directly own the land on which their property sits (Bulgaria) or more than one property (Cyprus) for example, and some countries are less economically or politically stable than your own which can mean that real estate related rules and regulations may change in the future.  Make sure you’re comfortable with the workings of the country you’re considering buying a vacation home in, and if in doubt seek professional advice about that country and the ambitions you hold for owning a holiday home in it.

Tip Two – Good Investment/Bad Investment

If you’re buying a vacation home with a hope that it will go up in value and be not only a family retreat but a great asset, know that real estate, just like any investment commodity, can go down in value as well as up.  Furthermore not all countries have a real estate economy the same as the one in your own country – a little research would be wise into the historic nature of the property market in your country of choice as well as predictions for its future.  While such data is not a direct indication of how well your investment will perform it will arm you with more data to hopefully make your decisions easier.

Tip Three – Title Deeds and Legalities

Legal systems and the title-deed registration process differ from country to country therefore know your legal rights and try to find out about the essential searches, surveys and title-deed checks that need to be conducted before you should commit to buying your overseas vacation home.  Never enter into any form of contractual agreement without the direct assistance of an independent lawyer and never accept someone’s word that a vacation home has its permissions and title deeds valid and up to date.  Insist on seeing and checking all important facts and data before signing on the dotted line.

Tip Four – Accessibility and Desirability

If you’re thinking about making an income from your vacation home or even hoping to holiday in it yourself regularly, one of the most important factors to bear in mind is the accessibility or otherwise of your vacation home.  If your real estate is difficult to reach, with many miles to traverse and complicated and expensive plane journeys to plan, then it will just become a less desirable commodity over time. While a vacation involves getting away from it all and escaping every day life, a vacation destination and home should be easy and affordable to reach.

Tip Five – Enlisting Assistance

Consider enlisting the help of a reputable real estate agent, an independent lawyer and if you want to make money from your vacation home, a property management service.  Such professionals can save you time, effort and money and they can make the whole process of buying and owning a vacation home that much simpler.  Make sure you take references, examine credentials and see qualifications before employing anyone to assist you however, and if at all possible seek recommendations because anyone who does a good job will always get good press!

What is Pre-Construction Real Estate Investing?

The idea of pre-construction investments when it comes to real estate is actually quite a clever way in which many have made millions. The theory is simple really. Invest in a property before when it is in the planning stage. Those who will be building these buildings need money and investors in order to do get the building off the ground. By investing (in many cases basically purchasing options to purchase) in the units, typically condo units in high demand areas, before the ground is broken investors often have the option of investing for pennies on the expected dollar once the building is complete and can re-sell the property at full market value once the building is complete pocketing the difference in the original investment and the asking price.

This is a win-win situation for many builders or ‘owners’ of the property in questions because ‘pre-selling’ the units allows lending agents to have confidence in the viability of the project as a money earner by selling many of the units sight unseen. The benefit to investors is that they are able to purchase at a much lower price pre-construction than afterwards and can sell afterwards at the full market value (or above in some high demand and under saturated areas for real estate).

This style of investing is not nearly as glamorous to some as flipping houses. There are no beast to beauty renovations. There are, however, some things that should be kept in mind while making this type of transaction.

First of all, no real estate venture is ever guaranteed to turn a profit no matter what the glossy little brochures tell you. With the current trends in property sales, this is typically not the best environment for pre-construction investing though these things tend to change on a regular basis and that market could be looking up again in the very near future.

Second, networking is more often than not the best way to break into this particular business. There are all kinds of fly by night would be real estate investors. The ones that manage to last are those that network with other real estate agents as well as those who have specific interests and experience with pre-construction investments. Join local groups in addition to online groups that deal specifically with this sort of investment in order to get more information more quickly. The costs involved might appear daunting at first but they are far less than the costs of getting in over your head by not having a grasp of even the most basic ‘ins’ and ‘outs’ of pre-construction real estate investing.

Third, develop a close-knit relationship with a realtor that specializes in this particular type of real estate investing. This could prove to be the most beneficial thing you will ever do in order to insure future success. Be developing the right relationship with the right realtor you can get information on new properties before they make it to the public sector. This puts you in the rare and wonderful position of beating the competition to the punch. This gives you a much better shot at receiving the rock bottom prices that are often missed by waiting too long to make the purchase.

Fourth, be prepared to hold onto the property for a little while if you need to do so. The problem with pre-construction investing is that there are no guarantees that when the time comes you will have been able to ‘seal the deal’. Things come up even when you have a buyer that is willing and eager to make the purchase. In other words, there are times when you will need to hold onto the property for a short while and sometimes as a long-term investment. Some options in the case of long-term holds would include renting the property out to vacationers if it is in a high demand tourist area. You can use your realtor to help with that. This allows the property to be earning some income until the sale can be made. Others decided to hold onto the property as a personal vacation home for themselves, friends, and family. In the end, the important thing is that there is a “Plan B” for the property should the deal fall through and you are left paying the monthly note.

Pre-construction real estate investing may not have the ‘name in lights’ appeal that other types of investing carry but it does provide a viable investment style that has the potential to bring in significant profits. The name of the game when it comes to investing is profits so keep this in mind when considering your investment options. This is one of the forms of investing that requires (in most cases) the least amount of capital up front.

Four Real Estate Investment Tips, that you can learn from Warren Buffet, and other Stock Investors

Some of the most successful stock investors ever have based their investing principles on value investing. Investors such as Benjamin Graham, Irving Kahn, and Warren Buffet, have used value investing to build vast empires of wealth.

Value investing was conceived by Benjamin Graham, and David Dodd, in their classic book, “Security Analysis”, written in 1934. Although they were talking about stocks, there is still a lot to be learnt from value investing that can be applied to other investment vehicles. This article will show four things that real-estate investors can learn from value investing…

1: Investing vs Speculating – In value investing, it’s important to make the distinction between being an investor, and being a speculator. In “Security Analysis”, it is defined as this:

“An investment operation is one which, upon thorough analysis promises safety of principle and an adequate return. Operations not meeting these requirements are speculative”.

So, there are 3 things needed for something to be an investment: – You need to have done thorough analysis. – You need to be reasonably sure that you won’t lose your money. – You need to be reasonably sure that you will make some money.

In terms of real-estate, this means that just buying and selling real-estate, does NOT make you an investor. If you’re buying properties at random, just because there is a boom and all property is going up in value, you are not investing. You are speculating.

There is nothing wrong with speculating, you just need to be aware when you are speculating, versus when you are investing.

2: Value vs Quality – Value Investing doesn’t really have any formulas, or rules. It is more of a theory, with some general principles. Because of this, there are many ways to do value investing, and different ways to apply it.

Benjamin Graham focused on buying stocks significantly below value, with little emphasis in the quality of the stock, in regards to their long term prospects.

This can be a useful strategy for a real estate investor, particularly when they are first starting out, and need to build up equity fast.

Warren Buffet still looks at the value of a stock, but puts a lot more emphasis on the quality of the stock. He only buys stocks that he thinks have good long-term prospects, with a bright future in front of them.

This is generally a good strategy for real-estate investors to move to later on, when they have built up their portfolio. Long term, well-chosen property will make significantly more capital growth than poorly chosen property, and may be worth buying even if it can only be bought at market value.

And with commercial real estate investment, it may be worth getting a lower rental yield, if this means you can have a high quality tenant, who will pay the rent reliably. This is a strategy that famous New Zealand commercial real estate investor Bob Jones has applied, with great success.

3: Margin Of Safety -“One of the most important principles in value investing is a margin of safety”.

Margin of Safety is the idea of making sure that you only invest if your calculations show that there is a significant profit to be made. There is no way your analysis can be 100% accurate, so the margin of safety gives you a buffer, to use when your calculations are slightly off, or you get worse than average luck, or any number of unexpected problems occur.

So when estimating the value of a stock, you use conservative estimates for earnings etc, to come up with the value. If your estimated value comes in at $10, then you don’t buy the stock if it’s currently selling for $9.75, because it’s too risky, and if your calculations are off, you wont be buying a bargain. If the price is currently $6 though, you might buy it, because you have a $4 margin of safety to use if you estimated incorrectly.

The same principle applies to real-estate.

Suppose you are looking at a deal, and you find you can buy some land for $100,000 and you can build a 4-bedroom house on it for $150,000.

If new 4-bedroom houses in the area are selling for $270,000 then should you do the deal? Theoretically, it will only cost you $250,000 to buy/build with a sale at $270,000 so you should make $20,000 profit.

But that isn’t much margin of safety. What if building costs blow out, and it cost more than $150,000 to build? What if you can’t sell it straight away so you have some holding costs? What if the other 4-bedroom houses in the area have much better kitchens than you realized, and you can actually only sell for $245,000?

There are a lot of unknowns here, and because your margin of safety is so small, unless everything goes right, you can quickly find yourself making a loss.

If on the other hand, 4-bedroom houses in the area are selling for $350,000 then you have a projected profit of $100,000. You can afford for a lot of things to go wrong, and you can still make a profit.

In the first case, if building costs go up by $50,000, the deal will cost you $30,000.

In the second case, because you have a much larger margin of safety, if building costs go up by $50,000 then you will still make a profit of $50,000.

Margin of Safety is a very important concept to all investors, and all real estate investors should think about it if they want to be around for the long-term.

4: The myth of Risk vs reward – Conventual wisdom says that to increase your reward in investing, you must increase your risk. This is often true, but the Magen of Safety principle can turn this around.

When margin of safety is used, a higher reward actually means a lower risk!

You can see this is the example above. The deal that is projected to make $20,000 is quite risky, whereas the deal with a projected profit of $100,000 is much safer, because a lot more can go wrong before a loss is made.

This doesn’t mean than high reward always means lower risk though. The conventual Risk vs Reward wisdom is still correct in general. So if you borrow more to buy a property, your risk and reward have increased. If you buy in a small town to get a higher rental yield, your risk and reward have increased.

This Risk vs Reward theory is only incorrect when directly applied to the Margin Of Safety concept. So if you buy something for $100,000 that all your analysis shows is worth $200,000, then your reward has gone up, while your risk has gone down.

Best commercial real estate investments

Considering investing in commercial real estate? The best commercial real estate investments are located all over the country. Due to the virtual crash of the residential real estate market, many savvy investors are switching to the commercial real estate market.

The best commercial real estate investments can be found all over the United States. In order to find the best commercial real estate investments you need to look in the up and coming neighborhoods or neighborhoods that are being rehashed within the city. Do not hesitate to think outside the box when deciding upon a commercial real estate investment. You can play it safe and earn a small profit or take a chance and make a million. Or lose. Taking a chance always involves risk.

For some people who have built homes or who have worked as project developers for others, the best commercial real estate investments would be those where they could put their knowledge as a project developer to good use. Instead of working for a company, the investor will be working for his or her self. The property must be purchased and developed into a strip mall, office complex or another commercial enterprise.

A project developer in the commercial real estate business is in a good position to invest in their own project, using the knowledge that they have gained on the job. They may have even made connections in different municipalities that will enable them to get their project approved quicker. In order to develop any property, commercial or residential, you have to be able to work with the municipality in which the real estate is located.

For those who have little or no real estate knowledge, the bet commercial real estate investments would be a group investment in property where someone else is doing all of the work and you need only invest capital. Professional people, particularly doctors, often make such investments. It is wise to spread your commercial real estate investments around if you are participating in group ventures or limited partnerships so that if one of them fails, the others may make up the difference.

Group real estate investments can range from a few partners getting together to purchase commercial real estate, to a large conglomerate of investors, each of which puts up a small amount of money and gets a small percentage in the property. This is generally done when malls or other large developments are built. This is one way the developer raises capital for the project. Once the project is completed, it is usually sold and the investors get a return on their investment that is usually a lot more than they could get in a bank, money market or even in most mutual funds.

There are many ways to invest in the real estate market today. Investing in commercial real estate can take more capital but is usually a safer investment than residential real estate. Your knowledge, skills and amount of capital you have to invest will determine the best commercial real estate investments that are right for you.