4 min read

The Role of Investment Real Estate in Your Financial Plan

A family with two young children sitting in the snow drinking hot chocolate in front of their investment real estate property.

Buying real estate is always a little daunting even when you’re excited about the property. Whether you’re buying your first house or your tenth piece of investment real estate, you know that closing the deal and committing to the purchase is going to impact your long-term financial plans. Hopefully the impact is largely positive—but you can’t know for sure what the future might hold. That’s why careful financial planning is so important before making any real estate transactions. 

Owning your primary residence certainly affects your financial plan in a lot of ways. As a homeowner you’re able to take advantage of some tax benefits every year, but you also have to be financially prepared for major and somewhat unpredictable expenses like a new roof or a flooded basement. Some homeowners leverage their equity to do things like secure low-interest loans or consolidate debt. 

In some cases, owning a home can become more of a burden to your financial plan than a benefit. If you need long-term care someday and want to qualify for certain health coverage, you’ll have to plan ahead to get any real estate out of your name so you meet the income eligibility requirements. And, here in Massachusetts where the estate tax threshold is just $1 million, owning a home may make your estate valuable enough that it owes taxes. (Which is one reason why careful estate planning is so important!)

But what about investment real estate? Buying income-earning property can impact your short-term and long-term financial plans in several significant ways. 

Investment real estate can provide a source of passive income (theoretically).

Real estate investing can take several forms. Buying another home in your area to rent out as apartments or as a vacation rental might be very profitable but will generally require a fair amount of ongoing work, unless you cut into profits by paying someone else to manage things like repairs and tenant turnover. Investing in land or a commercial building that has an existing long-term tenant might require less day-to-day activity but will still require some involvement on your part. 

For people who want to invest passively in real estate without investing time and labor in a physical building, real estate investment trusts (REITs) can be an attractive option. REITs function like mutual funds, allowing a group of people to pool money to finance investments; in this case, real estate that’s owned, managed and/or financed by the trust. Investors receive regular dividends with none of the responsibilities of ownership. Crowdfunding has also emerged as a buzzy real estate investment trend over the last few years. Some platforms are only open to accredited investors but others are open to the general public and have much lower minimum investments than REITs. 

Assuming your passive real estate investments do well, the income stream can create new opportunities in your financial plan. You could use it to max out contributions to a child’s 529 plan, invest it in your portfolio, boost your savings, pay down debt or use it for some other purpose that furthers the goals of your financial plan. A steady source of income is never guaranteed from a passive investment, though. Fluctuations in the housing and commercial real estate markets will naturally affect your returns. 

Investment real estate can generate significant tax advantages. 

Strategic investors and their tax advisors may be able to squeeze a lot of tax benefits out of real estate investments. Owners of rental properties can deduct mortgage interest, depreciation and a long list of expenses related to managing and maintaining properties, as well as certain business expenses. Until the Tax Cuts and Jobs Act expires, real estate investors who own pass-through businesses can also deduct up to 20 percent of their net rental income from their income taxes. 

Investors may even be able to avoid capital gains taxes while building increasingly valuable real estate empires. Selling one investment property and using the profits to buy another property of the same nature is considered a like-kind or 1031 exchange. Assuming all IRS criteria are met, an investor can do a 1031 exchange without recognizing any capital gains or losses on the sale of the first property. For example, you could sell one small apartment building and invest the proceeds in a larger, more profitable apartment building without paying capital gains taxes, giving you more money to roll into that next property.    

Investment real estate can diversify your portfolio. 

There are a lot of reasons why maintaining a diversified portfolio is an overall good thing for your financial plan. For one, investing in a range of assets and across a range of industries can (hopefully) allow your portfolio to hold onto some of its value even if one or more of your investments fails. Owning income properties and/or REIT shares might create some important balance in a portfolio that’s heavily invested in tech stocks, for example. If the tech sector is struggling but the real estate market is thriving, your entire investment portfolio won’t tank at the same time and force you to rework your entire financial plan. 

Investment real estate can become part of your financial legacy and estate plan. 

Could a piece of real estate you invest in today appreciate so much in value that future generations of your family can live off the income it generates? Who knows—but it’s always possible. 

Depending on your family and financial goals, sharing investment real estate with your children and other younger relatives could be a gratifying way to spread your wealth, get them involved with investing and help them develop their financial literacy. Gifting or bequeathing an income-earning property to a family member could even give them the real estate investing bug and set them on a lucrative career track following in your footsteps. Plus, it should be harder for one of your heirs to waste an inheritance of real property than it would be to waste a cash inheritance on an impulsive purchase. 

That said: Transferring real estate to loved ones can be complicated and isn’t always the best decision for everyone involved, so these are decisions to make with a lot of guidance from your financial and estate planning advisors. Careful planning ensures that your investment real estate isn’t an undue financial burden for whoever you pass it to next. 

Sachetta, LLC takes a holistic approach to every client’s financial planning needs. If you’re curious about whether owning investment real estate could help you achieve your unique and specific financial goals, our advisors want to help. Contact us today.