# Investment Property: Definition, Financing, and Types

## What Is an Investment Property?

Investment properties are [real estate](https://www.investopedia.com/terms/r/realestate.asp) assets bought to generate returns either through rental income, future resale, or both. Held by individual investors, groups, or corporations, these properties can be either long-term ventures or short-term flips—where investors renovate and quickly sell for profit. While often associated with real estate, 'investment property' can also refer to assets like art, securities, or collectibles purchased for future appreciation.

### Key Takeaways

*   Investment properties are real estate assets acquired to generate returns through rental income, future resale, or both.
*   These properties can be classified into residential, commercial, or mixed-use categories, each offering different income potential and investment strategies.
*   Financing investment properties is more challenging than primary residences, requiring at least a 20% down payment and strong credit.
*   Investors must report rental income to the IRS but can also deduct relevant expenses, and selling an investment property may result in a taxable capital gain.

## How Investment Properties Operate and Generate Income

Investment properties are not used as a primary residence. They generate income like dividends, interest, rents, or royalties, which are not part of the owner's regular business. How an investment property is used significantly affects its value.

> **Important**
>
> Investment properties generate income and are not primary residences.

Investors often study to find the most profitable use of a property. This process is called finding the property's highest and best use. For example, if an investment property is [zoned](https://www.investopedia.com/terms/z/zoning.asp) for both commercial and residential use, the investor weighs the pros and cons of both until they ascertain which has the highest potential [rate of return](https://www.investopedia.com/articles/basics/10/guide-to-calculating-roi.asp). They then utilize the property in that manner.

An investment property is often referred to as a second home. But the two don't necessarily mean the same thing. For instance, a family may purchase a cottage or other vacation property to use themselves, or someone with a primary home in the city may purchase a second property in the country or [in another state](https://www.investopedia.com/articles/mortgages-real-estate/10/out-of-state-property.asp) as a retreat for weekends. In these cases, the second property is for personal use—not as an income property.

## Various Types of Investment Properties Explained

### Residential

Rental homes are a popular way for investors to supplement their income. An investor who purchases a residential property and rents it out to tenants can collect monthly rents. These can be single-family homes, condominiums, apartments, townhomes, or other types of residential structures.

### Commercial

Income-generating properties don't always have to be residential. Some investors—especially corporations—purchase commercial properties that are used specifically for business purposes. Maintenance and improvements to these properties can be higher, but these costs can be offset by bigger returns. That's because the leases for these properties often command higher rents. These buildings may be commercially-owned apartment buildings or retail store locations.

### Mixed-Use

A mixed-use property can be used simultaneously for both commercial and residential purposes. For instance, a building may have a retail storefront on the main floor, such as a convenience store, bar, or restaurant, while the upper portion of the structure houses residential units.

## How to Finance Your Investment Properties

While borrowers who secure a loan for their primary residence have access to an array of financing options, including [FHA loans](https://www.investopedia.com/terms/f/fhaloan.asp), [VA loans](https://www.investopedia.com/terms/v/valoan.asp), and conventional loans, it can be more challenging to procure financing for an investment property.

Insurers do not provide [mortgage insurance](https://www.investopedia.com/terms/m/mortgage-insurance.asp) for investment properties, and as a result, borrowers need to have at least 20% down to secure bank financing for investment properties.

Banks also insist on [good credit scores](https://www.investopedia.com/articles/personal-finance/120414/what-good-credit-score.asp) and relatively low [loan-to-value ratios](https://www.investopedia.com/terms/l/loantovalue.asp) before approving a borrower for an [investment property mortgage](https://www.investopedia.com/the-best-investment-property-loans-11733515). Some lenders also require the borrower to have ample savings to cover at least six months' worth of expenses on the investment property, thereby ensuring the mortgage and other obligations will be kept up to date.

## Navigating Tax Implications for Investment Properties

If an investor collects rent from an investment property, the [Internal Revenue Service](https://www.investopedia.com/terms/i/irs.asp) (IRS) requires them to report the rent as income, but the agency also allows them to subtract relevant expenses from this amount. For example, if a landlord collects $100,000 in rent over the course of a year but pays $20,000 in repairs, lawn maintenance, and related expenses, they report the difference of $80,000 as self-employment income.

If an individual sells an investment property for more than the original purchase price, they have a [capital gain](https://www.investopedia.com/terms/c/capitalgain.asp), which must be reported to the IRS. For 2021 and 2022, capital gains tax rates are either 0%, 15%, or 20% for most assets that are being held for over a year.

In contrast, if a taxpayer sells their primary residence, they only have to report [capital gains tax on a home sale](https://www.investopedia.com/ask/answers/06/capitalgainhomesale.asp) in excess of $250,000 if they file individually and $500,000 if they are married and filing jointly. The capital gain on an investment property is its selling price minus its purchase price minus any major improvements.

To illustrate, imagine an investor buys a property for $100,000 and spends $20,000 installing new plumbing. A few years later, they sell the property for $200,000. After subtracting their initial investment and capital repairs, their gain is $80,000.

> **Article Sources**
>
> 1.  Internal Revenue Service. "[Topic No. 409 Capital Gains and Losses](https://www.irs.gov/taxtopics/tc409)." Accessed Dec. 26, 2021.
>     
> 2.  Internal Revenue Service. "[Topic No. 701 Sale of Your Home.](https://www.irs.gov/taxtopics/tc701)" Accessed Dec. 26, 2021.