The Unofficial Guide to Real Estate Investing by Spencer Strauss and Martin Stone_4

&20321(1762)5(7851 land and the existing structure that sits on it. Naturally, this drives prices up. Rural areas, on the other hand, tend to have plenty of va-cant land available. This greater availability of land makes it pretty simple to find willing sellers; the end result is lower prices for real estate in these areas. Transferability refers to the ease of buying and selling any com-modity. As you know, investments such as stocks and bonds are fairly liquid because you can transfer them from one owner to an-other pretty quickly. Real estate, on the other hand, can’t trade hands nearly so fast. This is usually related to the number of poten-tial buyers and the ability, or lack thereof, to find adequate financ-ing. There may be many buyers and hundreds of lenders for the modest two-bedroom/one bath home you are trying to sell, but how many buyers and lenders would be interested or qualified to buy the Chrysler Building? Significantly fewer. Utility refers to the usability of property. With real estate, the value of a property is directly related to its highest and best use. For example, a small parcel of land in a residential area will probably be limited by the potential value of the home that can be built on it. A large commercial lot close to a highway entrance or a shipyard, however, could be an extremely valuable location to build a manu-facturing plant. According to this principle, the greater the utility value, the greater the price of the property. Finally, the demand principle of appreciation results from the upward desirability of the property. This is the same phenomenon that affects the price of tickets to any major event that sells out at a moment’s notice. Think about the scalpers that roam the parking lot of the Super Bowl or a Bruce Springsteen concert, for example; the reason they are able to get top dollar for their tickets is because the demand for their product is so great. If these scalpers were hawking tickets to see a clown making balloon animals, odds are they wouldn’t attract many top-dollar buyers. 6(&85(<285),1$1&,$/)8785(,19(67,1*,15($/(67$7( General trends in the economy also play a significant role in changes in demand. Many investors move from one investment vehicle to another based on the investment’s ability to produce a buck. When stocks are up, their money is there. When bond yields increase, the stocks are sold for bonds. When real estate is moving, they start buying. This sends the message to all the small investors that it is time to buy. The end result is an increased demand for a product that is in limited supply. In times like these, appreciation rates naturally increase. To give an example of how appreciation affects price, let’s make an estimate using our example property. Remember, we bought the example property for $279,000. We’ll assume the appre-ciation rate is 5 percent per year. At that price, and with that appre-ciation rate, the return looks like this: Price of Property $279,000 Appreciation Rate ´ 5% Total Return $213,950 We can calculate the percentage return for the first year of ownership by dividing the appreciation by the down payment: Appreciation $13,950 ÷ Down payment $8,370 = 166% Return Yes, a 166 percent return isn’t half bad. Remember, we put only 3 percent of the purchase price down to purchase this prop-erty and the bank financed the balance. Therefore, leverage was the reason we achieved such a phenomenal result. As you can see, this modest appreciation rate of just 5 percent translated into a tre-mendous return on our investment. &20321(1762)5(7851 7$;%(1(),76 The fourth and final component of return is tax-sheltered ben-efits. These benefits are the paper losses you can deduct from the taxable income you receive from the property. Because you are the owner of an investment property, the Internal Revenue Service allots you an annual depreciation allowance to deduct against your income. The premise is that this deduction will be saved up and used to replace the property at the end of its useful life. For most businesses, this is a necessary deduction because equipment like fax machines and computers wears out after time. But when it comes to real estate, most property owners don’t live long enough, or keep their buildings long enough, for them to wear out. There-fore, the tax saving from the deduction is a profit that is added to your overall financial return. There are a few different methods that you can use to deter-mine your annual depreciation allowance. The most common method relies on using the land-to-improvement ratios found on your property tax bill. Don’t be concerned if the actual dollar amount shown on the tax bill doesn’t mesh with what you’re pay-ing for the property; it is the ratio we are looking for. The idea is to use the ratio numbers to get the percentage you need to determine the value of the improvements. To do this, use the following calcu-lation: Assessed improvement value ÷ Total assessed value = % Value of improvements Once you know the percentage value of the improvements, you then multiply that by the sales price to get the amount of depre-ciable improvements: 6(&85(<285),1$1&,$/)8785(,19(67,1*,15($/(67$7( % Value of improvements ´ Price = Depreciable improvements Keep in mind that you don’t have to establish your deprecia-tion schedule until you file your tax return. In most cases, there will usually be sufficient time between the property closing and the tax filing deadline to discuss the method you want to use with your tax professional. 02`,),(`$&&(/(5$7(`&2675(&29(5< 6<67(0(0$&56 The tax code change in 1986 established the Modified Accel-erated Cost Recovery System (MACRS). This code established the recovery period, or useful life, of assets to be depreciated. Like much of the government’s tax code, these periods usually bear no correlation to reality with regard to the useful life of an asset. None-theless, in the case of improved property there are two classes of property and two recovery periods that were established. They are: Type of Property Residential Nonresidential Recovery Period/Useful Life 27.5 Years 39 Years Note that it doesn’t matter what the true age of your property is; if your property is residential, you use 27.5 years. If your prop-erty is categorized as nonresidential, you use 39 years. Additionally, when using this method of depreciation, you will have the same amount of annual depreciation expense over the entire useful life of the building. To arrive at the annual expense, you simply divide the value of the depreciable improvements by the recovery period, which gives you your deduction. &20321(1762)5(7851 Now let’s take a look at the calculation using the example property. First we find the value of the improvements and then divide that value by the recovery period. We are paying $279,000 for the property and are using the land and improvement ratios from the tax bill as described earlier. The tax bill shows the improvements assessed at $40,000 and the total assessed value of the property at $65,000. We would then calculate the depreciation allowance as follows: $40,000 Improvements ÷ $65,000 Total assessed value = 61.5% Improvements We would then multiply the sales price by the improvement percentage to get the amount of depreciable improvements: $279,000 ´ 61.5% = $171,585 Depreciable improvements Finally, to determine our annual appreciation allowance, we divide the depreciable improvements by the recovery period: $171,585 ÷ 27.5 = $6,239 Annual depreciation allowance Before we can determine what kind of savings our deprecia-tion allowance gives us, we first need to review two other code changes made in the tax reform of 1986. They are important be-cause these changes limit your ability to use the excess depreciation to shelter the income from your other job. The first new code change classifies real estate investors into either “active” or “passive” investors. Passive investors are defined as those who buy property as limited partners or with a group of more than ten other partners. As a passive investor, you can use the depreciation deduction to shelter any profit from the property. Any excess write-off must be carried forward to be used as the profit ... - tailieumienphi.vn