Lifepoint Financial Design – LifePoint Financial Services – Mike Metzger Financial Planning

Whaaat?? A financial advisor telling you to put extra cash towards real estate? There is no need to re-read the title of this article, you read it correct the first time.

As a CERTFIED FINANCIAL PLANNER™ working with real estate agents and other high-income professionals, it would be foolish for me to ignore the benefits that real estate can provide to a client’s overall financial position. In fact, it’s often a part of the Lifepoint Planning Solutions. I’ll dive into why I am such an advocate of having rental real estate in a bit, but first I want to give some background to this blog.

Why most financial advisors do not talk about real estate investments:

The short and simple answer is that most financial advisors are not structured to be paid on it. The financial services industry, especially larger brokerage institutions, has lacked creativity in structuring compensation for their services. Most Advisors are paid through a couple of structures; commissions on trades or through sold products, or on a percentage fee of managed liquid assets. It is understandable then as to why advisors do not recommend using your liquid money to purchase real estate, because there is no compensation to the advisor.

Financial Planning is supposed to be about helping to better one’s financial position to accomplish short and longer-term life goals. However, I would argue that owning real estate as a part of an overall diversified portfolio is one of the best methods to bettering one’s financial position for the following reasons:

1. Base-line inflation-protected income

Building liquid assets for future retirement expenses is very important, don’t get me wrong. Having retirement savings in the form of traditional stocks and bonds through 401(k), IRA, traditional brokerage accounts, Health Savings Accounts (HSA), and others, is vital to living out retirement goals.

But, wouldn’t it help to have a higher base through rental income so that you’re not drawing so heavily on those hard-earned savings? It just seems to make sense, right? Not only that, but as inflation rises, so do your monthly rentals. So, you even have a COLA on your homemade pension plan.

2. Deductions to help your tax bill

The amount of deductions that you can take on your real estate is plentiful. For starters, mortgage interest, with some limitations, and associated costs are deductible on your tax return. Beyond this, items like property taxes, operating expenses, depreciation, repairs, maintenance, property management expenses, and even home-equity lines of credit may also be deductions on your tax return.

With a list that long and that liberally open, it’s hard to ignore the impact that real estate can have on your taxes. And when the goal of financial planning is to improve one’s financial position so that they can see their life goals come to realization, isn’t that exactly what is happening here?

3. Capital Gains Treatment

To qualify for long-term capital gains, an asset needs to be held for 12 months or longer. With traditional stock investment vehicles, when a long-term asset is sold for a gain, it triggers capital gains taxes. Although you are given a favorable tax rate (15% or 20% for most high-income earners), the IRS doesn’t give you any freebies on those gains.

With real estate there is even better news. Not only did some of those improvements into your home help reduce your gain exposure when you go to sell a property, but the IRS does you one more solid. Capital gains are exempt from taxation up to $500,000 (must meet the IRS qualifications to receive the exemption). In addition, this exemption can be used more than once. The IRS is not very charitable, but it certainly seems like they were in a good mood on this one.

4. Passive-Income and Pass-Through Deductions

Created by the Tax Cuts and Jobs Act (TCJA), passive rental income may qualify for a pass-through deduction which allows investors to deduct up to 20% of their net business income and thus reducing their effective income tax rate by 20%.

Here’s how it works. Let’s say you have $12,000 of income from one rental property and $8,000 of loss on another. The $8,000 loss will reduce your net income to $4,000; the difference between the two.

Now instead, let’s reverse the two giving you a net loss of $4,000. The TCJA act will allow you to reduce employment income now as a result of that net loss and effectively reducing your overall tax rate. This can provide a pretty nice strategy to reducing taxes in a high-income tax year.

5. 1031 Exchange

With a lot of my audience being real estate agents, this is a concept already very well known. The IRS code section 1031 allows an investor to defer a capital gain from selling a property in exchange for purchasing another property that is equal or greater in value. This could provide tremendous value to a client’s tax situation and asset side of the balance sheet.

Likewise, with traditional investments, there are similar tax benefits through IRS code section 1035. However, it’s not really a one-for-one scenario. For example, I couldn’t just exchange my Apple stock for Samsung stock and avoid all capital gains.

In all fairness, there are some serious considerations:

· Not all real estate markets are created equal– The real estate market in San Luis Obispo, CA is going to be completely different from the real estate market in Salt Lake City, UT (Lifepoint Financial Design has offices in both locations). Meaning that just because you bought a house, does not guarantee that you can have rental demand or gains to defer to begin with. So, as powerful of a tool that real estate can be for your overall financial picture, you have to know what markets will produce value to you.

·  It can take some serious time and effort- Look, a rental property does not always cash flow and being a landlord can be a real pain. Things don’t always work according to our wishes and real estate property falls right into that. Furnaces cease to work, water leaks happen, and a tenant might suddenly stop paying rent. Murphy’s law can catch you and cost you some serious money. So, it is important to realize that real estate will not always feel like a great investment just as much as a stock market correction feels to market investor.

Real estate may not be a popular subject among many Financial Advisors, but as a CERTIFIED FINANCIAL PLANNER™ I am fiduciary who must look out for best interest of my clients. To ignore the benefits of physical real estate investments would be a disservice. With the aforementioned benefits, pursuing your life’s goals may become that much easier. Of course, diversification and moderation is an important concept for all of life, and that requires a strategic and structured plan.

If you are interested in developing a plan that’s customized to your needs, I can help.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal.

No strategy assures success or protects against loss.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

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