10 Tips to Know Before You Become a Landlord
By: Alexander Sway
Tags: Financial Freedom, Investing, Wealth, Real Estate Investing, Money

10 Tips to Know Before You Become a Landlord

1. Can you afford to be a Landlord?

Do you know your way around a toolbox? How are you at repairing drywall or unclogging a toilet? Sure, you could call somebody to do it for you or your could hire a property manager, but that will eat into your profits. Property owners who have one or two homes often do their own repairs to save money.

Most people think they can sign the rental agreement and the work is over. But it takes a full time job attending to the needs of tenants and maintaining a property. Be sure to be mentally prepared for the time, energy and resources it takes to take on a rental property.

2. Keep a Cash Cushion for Rainy Days

Experienced investors will keep a cash cushion for ‘rainy days’. This includes covering the cost in-between renters, market changes, economic crisis, un-evictable tenants and/or unexpected damage and repairs. I have heard many stories where landlords purchased a rental property but found out that their wireless internet provider did not cover their area. Thus preventing any tenants from renting the place for months.

That’s why its important to imagine as many possible problems and calculate a cash cushion to address the issues should they arise.

3. Secure Roughly 20% Downpayment

Investment properties generally require a larger downpayment than do owner-occupied properties; they have more stringent approval requirements. The 3% you may have put down on the home where you currently live isn’t going to work for an investment property. You will need at least a 20% downpayment, given that mortgage insurance isn’t available on rental properties. You may be able to obtain the downpayment through bank financing, such as a personal loan.

4. Find the Right Location

The last thing you want is to be stuck with a rental property in an area that is declining rather than stable or picking up steam. A city or locale where the population is growing and a revitalization plan is underway represents a potential investment opportunity.

When choosing a profitable rental property, look for a location with low property taxes, a decent school district, and plenty of amenities, such as parks, malls, restaurants, and movie theaters. In addition, a neighborhood with low crime rates, access to public transportation, and a growing job market may mean a larger pool of potential renters.

5. Calculate Estimated Costs

Costs are the make or break for rental properties. Every extra bit of work and maintenance can eat away at the already thin profit margin. The more expensive the home, the greater your ongoing expenses will be. Its imperative to calculate your costs including, home owners association fees, property tax, utilities, landscaping…to name a few. In addition, experts advise never to buy the nicest house for sale on the block, ditto for the worst house on the block.

6. Keep in Mind Your Liquidity Options

One of the problem areas of owning a rental income in comparison to other investments include the lack of liquidty. Unlike stocks, you can’t instantly sell real estate if the markets go sour or you need cash. However, you can be prepared with other options to use your rental property and lines of credit. This way you can have the best of both worlds, owning rental properties while having a quick supply of cash to use on hand.

7. Look for High Appreciation Areas

Wall Street firms that buy distressed properties aim for returns of 5% to 7% because, among other expenses, they need to pay staff. Experts set a goal of a 10% return in rental income. In my experience, both these numbers are optimistic to say the least. The national average appreciation rate doesn’t even beat inflation, around 3%. Most people give too much emphasis on the rate of return for rental income but don’t look for high appreciation areas.

For example, I have helped several investors find rental properties in my local area and the past two years average return on appreciation is 15% and 16%. Ask Alex for help on finding your own high appreciating rental property!

8. Pay Zero Tax On Your Next Rental Property with 1031 Exchange

Real estate investors can defer paying capital gains taxes using Section 1031 of the tax code, which lets them sell a rental property while purchasing a “like-kind” property, and pay taxes only after the exchange is made. Legally speaking, the term “like-kind” is broadly defined. An investor need not swap out one condo for another or trade one business for another. As long as both properties in question are income-generating rental units, they’re fair game.

But timing is key with this method, as investors have just 45 days from the date of a property sale to identify potential replacement properties, which they must formally close on within 180 days. And if a tax return is due (with extensions) before that 180-day period, investors must close even sooner. Those who miss the deadline must pay full capital gains taxes on the sale of the original rental property.

9. You Can Turn Your Rental Property Into A Your Primary Residence

Selling a home you live in is more tax beneficial than unloading a rental property for a profit. IRS Section 121 allows people exclude up to $250,000 of the profits from the sale of their primary residence if they’re single and up to $500,000 if they’re married filing jointly. To qualify, investors must own their homes for at least five years and must have lived in them for at least two of those five years. The years as a personal residence do not have to be consecutive.For this reason, some investors choose to convert rental properties into their primary residences.

The deduction amount depends on how long the property was used as a rental versus its use as a primary residence. Additionally, a taxpayer may not exclude the portion of the gain that was previously attributable to a depreciation deduction. This is known as depreciation recapture, specific to rental properties, and the amount previously taken as a depreciation deduction is taxed at a recapture rate of 25%.

10. Buy A Home with An Irrevocable Trust and Avoid Estate Taxes

An irrevocable trust does not allow modification or terminations of the trust without the permission of the beneficiary. The trustee acts as a fiduciary who is responsible of managing the assets for the beneficiary. A fiduciary is someone who acts or manages assets on behalf of someone else.

Often, an irrevocable trust is used to avoid taxes on gifts that are above the taxable limit — in this case, real estate. Irrevocable trusts can also be useful in situations where you want to protect the estate from possible future financial problems.

For example, let’s suppose you have built a sizable estate, but your children fall on hard financial times later in life. Irrevocable trusts can protect assets from creditors given that assets were put into them before there were credit problems. However, it’s extremely important, with an irrevocable trust, that you’re confident in the selection of your beneficiaries.