|
Investing in Real Estate
Are you considering buying a 2nd property? If so you are now among the millions of people each year who consider buying investment Real Estate.
But are you ready for the next step to actually buy a rental property? Before you dive in, make sure you do some research first and find out what it is really like to be a landlord. There is a lot to know and it can be a lot of work. But that does not mean it is not worth it. If you want to be successful, you must understand what to expect before you begin investing in Real Estate.
We have a number of Important reports to help you get started, so feel free to click on any title that is of interest to you. Remember that in order to be successful you will need a team of professionals who can support you through this process. Contact us any time and we will help you get started on your way to financial freedom!
1) Real Estate Investing Made Simple
Talk to any successful real estate investor, builder, or developer and he or she will tell you that a good Realtor on your side is critical to success. While now becoming an interest of the masses, real estate has been a solid investment vehicle for ages. Experienced real estate investors understand that it offers a wealth of tax advantages, high return on capital (ROC), while retaining a level of stability unseen in any other investment product.
Owning rental property can be very rewarding financially and otherwise. While it is possible to sit back and collect income year after year without doing any work on your property, it is not a very realistic expectation if you want to maintain a profitable investment for years to come. Finding a home rental or apartment rental that will reap you a net profit each year is can be difficult in our active market, and realizing an eventual return on your investment or selling the rental property in 20 years for a large profit will likely take some regular effort on your part.
Becoming a successful rental property owner requires that you do whatever it takes to rent your property, keep your tenants happy and maintain your property so it can be easily rented year after year. That means you must actively seek renters to fill your vacancies, respond to your tenants needs and take the time to make repairs that will last and even increase your property value. Anyone can pick up a roller and paint a room so it looks pretty. But not everyone can fix a leaking pipe or replace a broken windowpane. Make sure you know what you are doing, have someone that can help you or be prepared to pay for repairs.
When choosing an area where to buy a rental property, there are several things to consider including, distance from your home, supply of potential tenants, average rents you can collect and the ability of tenants in that area to pay you. There are many advantages to renting in an area such as a college community because there is always and ample supply of tenants, rental income is usually higher than most other areas, and vacancies can be limited. Also, students often have parents who will pay their rent. This is also a potential risk of damage to the property as younger tenants can sometimes be more irresponsible than a family or professional couple.
Take some time to read articles on renting and becoming a landlord before you move ahead and buy a rental property. Participate in on line forums that discuss the pros and cons of buying rental property. Talk to other rental property owners to hear their thoughts on being a landlord. Be sure to ask what it is like to rent to students, how other landlord’s deal with vacancies, and what other issues they have renting in a college community. Investment real estate can be a worthwhile investment if you are well prepared to face any challenges that may come along. We take pride in assisting and educating real estate investors of all calibres; from beginning to highly experienced investors, Kim & Gord offer a wide variety of products and services packaged in a turn-key offering, custom-tailored to suit today’s residential real estate investor. Service Our services for residential investors are systematically designed to ensure, and add to, your success. Our business model revolves around a three-pronged approach of Service, Selection, and Value. We also regularly invest in residential Real Estate ourselves, so we don’t just teach, we do! We are resounding client advocates. Bottom line: we will utilize our resources for your maximum gain. Just ask our clients! Selection We offer our clients a wide variety of "choice-picked" properties- single family housing, strata properties recreational and land. Bottom line: at the heart of it all, we will utilize our property resources to maximize your profitability and success. We also have a large network of referral Realtor that specialize in properties all across the world! Value We are a value-driven organization, which is why our clients continue to foster winning relationships with us. We feel that our service and selection must always be monitored and improved upon to ensure our mutual success Bottom line: your bottom line affects our bottom line; we invest time, energy, and money into creating systems that will keep our clients coming back again and again, then complimenting us with a referral.
Overview
There is a concept out there that discusses buying ten houses over a ten year period, and by the time you buy the tenth house in the tenth year, the first house has doubled. If you bought it for $200,000 and it appreciated 7.2% a year (the national average is 7.7%), it would be worth $400,000.
In year ten you cash out refinance the first home to take $100,000 to $200,000 out, and this cash is tax free (until you sell the property, of course.) The eleventh year you can do this on house #2, because it has now doubled in ten years. You can do this over and over again, and by the 21st year, your first house has doubled again, and you can continue pulling money out until you die, sell the property, or live in the property for two years to claim the capital gains exemption. I’ve explained this scenario to many, many of my clients, but surprisingly, many of my closest associates and friends have not yet heard it. This is why I’ll take time to explain the whole thing right now.
The Plan
You’ve got the general idea already. You need to buy several houses, and as they double in price, you can refinance them to pull the money out. The reason most people use ten houses and ten years in their plan is due to a pretty cool concept called the “Rule of 72.” This rule says that if you take your average appreciation rate and divide it into 72, you’ll learn how many years it will take to double. In other words, if your average annual appreciation rate is 7.2, by dividing 7.2 into 72, you get 10, or ten years to double. If your average appreciation rate is 10%, it will take you 7.2 years to double. As the national average appreciation rate is 7.7%, it’s close enough to ten years. If you could bank on 10%, you could make the plan “7 Houses in 7 Years.” You get the point.
Another misunderstanding is that you should only buy one house per year. Obviously, if you buy three houses a year the plan works fine, you’ll still need to wait the same amount of time (ten years in our 7.2% appreciation scenario), but if you buy four in the first year, by year eleven you have four houses that have doubled, and so on year twelve when you dip into house #2, the house has MORE than doubled.
Study the Table 1 below. You’ll notice several things. First notice how House 1 appreciates over the ten years. In Year 11, your house is worth just over $400,000, or a little more than doubled in price (funny how that worked out, eh?) Now you have a little more than $200,000 in equity (you have the little extra that it appreciated, but you also have the initial down payment as equity in the house.) Because these are non-owner occupied properties, it’ll be quite challenging to pull ALL the equity out. There are products that allow you to do this, but the rates are considerably high and it’s pretty hard to find and utilize these products. More reasonably you’ll leave 10-20% into the property. For the exercise below, I have shown taking $150,000 of the $200,000+ of equity you have. This will also improve the cash flow of the house because you still need to own and rent the property.
One of the negative issues with this plan that is rarely discussed is how inflation devalues the idea of $150,000. But if inflation is 4% and houses annually appreciate 7.2%, the value of $150,000 in ten years will be worth $100,000 in today’s money. Due to inflation, that degrades over the next ten years to about $68,000 in today’s money. Funny enough, if you run the same numbers over two ten year cycles, you’ll be able to pull $350,000 TAX FREE/DEFERRED a year, and that’s worth $160,000 in today’s money. According to this theory, your quality of living gets better by about 50% each cycle.
Raise the cost of inflation, things get less favorable. Increase the appreciation, things get much better. You really can’t control inflation, but you can influence how your properties appreciate. While buying and selling properties takes a little wind out of the sails of this method, it would be more than offset by finding a property that is appreciating much better than your current properties.
One thing to consider is that when you pull the money out, you’ll need to be considerate of the rent and how the increased debt load will affect your cash flow. This isn’t a show stopper, but it is something to realize. Additionally, you might go one or two cycles where the rent will be a premium, but once the houses start seeming old compared to the newer properties that are produced twenty years from now, the rent compared to the value will drop off. Additionally, older houses tend to appreciate less than newer. Like most things in real estate, there are many, many variables, but on the whole, this is a very sound technique.
One of the interesting aspects that is available today is the ability to avoid capital gains on a huge portion of the profit by living in the house for two years. In other words, if you wanted to, on year 21 you could live in House 1 for two years, and then sell it. As your gain will be about $500,000 (you can write off maintenance and other expenses, as well as the cost to buy and sell), the money would be TAX EXEMPT (for two people, as the exemption is CURRENTLY $250,000 per person, max of $500,000). You could spend the next 20 years liquidating all of your properties, tax free.
Another way to go would be to 1031 Tax Exchange the properties. You could sell two or three “older” properties and buy newer, bigger properties and rent them out. Once you satisfy the IRS’s criteria for you to have legitimately purchase them for investment property (successfully rent it out for a year, maybe?) You could move into this newer house, live in it, and use the capital gains exemption.
Needless to say, there are very many options in real estate investment. If you like this idea, or if you’re looking for more ideas like these, visit www.NARREIA.com, the official website of the National Association of Residential Real Estate Investment Advisors. Although this is a US based site we find it full of useful information like this and is free to use. There you’ll find a free Cash Flow Analysis worksheet for Excel as well as a Forum to discuss real estate investment.
(As the width of this forum is too narrow for the entire chart, the far rigth column "House 10" has been eliminated. The point is still clear.)
Table 1
Year | House 1 | House 2 | House 3 | House 4 | House 5 || House 6 | House 7 | House 8 | House 9
Year 01 $200,000
Year 02 $214,400 $200,000
Year 03 $229,837 $214,400 $200,000
Year 04 $246,385 $229,837 $214,400 $200,000
Year 05 $264,125 $246,385 $229,837 $214,400 $200,000
Year 06 $283,142 $264,125 $246,385 $229,837 $214,400 $200,000
Year 07 $303,528 $283,142 $264,125 $246,385 $229,837 $214,400 $200,000
Year 08 $325,382 $303,528 $283,142 $264,125 $246,385 $229,837 $214,400 $200,000
Year 09 $348,809 $325,382 $303,528 $283,142 $264,125 $246,385 $229,837 $214,400 $200,000
Year 10 $373,924 $348,809 $325,382 $303,528 $283,142 $264,125 $246,385 $229,837 $214,400
Year 11 $400,846 $373,924 $348,809 $325,382 $303,528 $283,142 $264,125 $246,385 $229,837
Year 12 $429,707 $400,846 $373,924 $348,809 $325,382 $303,528 $283,142 $264,125 $246,385
Year 13 $460,646 $429,707 $400,846 $373,924 $348,809 $325,382 $303,528 $283,142 $264,125
Year 14 $493,813 $460,646 $429,707 $400,846 $373,924 $348,809 $325,382 $303,528 $283,142
Year 15 $529,367 $493,813 $460,646 $429,707 $400,846 $373,924 $348,809 $325,382 $303,528
Year 16 $567,482 $529,367 $493,813 $460,646 $429,707 $400,846 $373,924 $348,809 $325,382
Year 17 $608,340 $567,482 $529,367 $493,813 $460,646 $429,707 $400,846 $373,924 $348,809
Year 18 $652,141 $608,340 $567,482 $529,367 $493,813 $460,646 $429,707 $400,846 $373,924
Year 19 $699,095 $652,141 $608,340 $567,482 $529,367 $493,813 $460,646 $429,707 $400,846
Year 20 $749,430 $699,095 $652,141 $608,340 $567,482 $529,367 $493,813 $460,646 $429,707
Year 21 $803,389 $749,430 $699,095 $652,141 $608,340 $567,482 $529,367 $493,813 $460,646
Year 22 $861,233 $803,389 $749,430 $699,095 $652,141 $608,340 $567,482 $529,367 $493,813
If you own or control property that you rent out to others, even to your own incorporated company, you must report the rental income and prepare form T776, Statement of Real Estate Rentals (see example). You must keep detailed records of all money collected and paid out. Most of the expense items on the rental schedule are obvious, but you should be able to back them up with receipts. Revenue Canada now wants to know how many units are available for rent for each property listed. This applies to residential rentals, so if your rental property is commercial or industrial, enter zero.
4) RENTAL EXPENSES- PART DEDUCTIBLE AND FULL DEDUCTIBLE This is provided for informational purposes only and should not be relied on without council from your Lawyer or Accountant
If an expense applies to the whole structure, and you use part of that structure personally, put the expenditure in the `part’ deductible column. If the expenditure applies to the rental area only (as with commissions or advertising for rent expenses), put the expense in the `full’ deductible column.
You might, for instance, have a mortgage on the whole building and the money was used to buy the building. The interest expense on this mortgage would go in the `part’ deductible column. If you had a second mortgage on the whole property, but the money was used exclusively to build the rental suite, you would charge "ALL" the interest to the `full’ deductible column. One commonly overlooked deduction is the interest charge on a credit card when the card has been used to buy a fridge, stove, carpet, etc., for the rental house.
MORTGAGE INTEREST (other interest) If there is more than one mortgage on the house relating to the purchase of the investment property, be sure to claim the interest on all of them. The interest on any other money borrowed to purchase the property is also deductible no matter what was used as security. One difficulty encountered here is that very few people seem to know how much mortgage interest they have paid in a year, even though it is usually the largest single expense in the operation of a property. These people know the amount of the mortgage payment that they make every month, but that is not the interest figure. At any rate, make sure you read INTEREST DEDUCTIONS at Line 221. MAINTENANCE AND REPAIRS The big problem here is, "what is a repair, and what is a capital expense?" A good explanation was given in 1962 by Mr. Justice Abbott in the Haddon Hall Realty case. He said, "Among the tests which may be used in order to determine whether an expenditure is an income expense or a capital outlay, it has been held that an expenditure made once and for all with a view to bringing into existence an asset or an advantage for the enduring benefit is a trade of a capital nature. " Where this really becomes important for most people is when there is a new purchase. At several real estate courses I have attended, I hear the expert up front tell the class or attendees that they should buy a junker, fix it up, and rent it. They always paint glowing reports about all the tax deductions they can expect because of the expenses. In these cases, ANY SINGLE EXPENSE you KNOW you have to make when you BUY the property, is NOT deductible at all, (not even one can of paint). All expenditures, (both money and trade), used to put property into rentable condition, are of a capital nature, and may be depreciated over the years.
INSURANCE Few people carry enough insurance in rental situations. The cost is deductible; buy what you need.
Make SURE that your policy recognizes the rental nature of the house. Remember that if the house is left empty for more than thirty days, the policy is invalid. Make sure that you or someone else visits every twenty days or so if your tenant takes a vacation for a couple of months. Make sure that your Public Liability is enough. At a convention on Sexual Assault (Feb 28, 1986 - Bayshore Inn, Vancouver), a lawyer from Campbell River, B. C. presented a paper which indicated that a landlord could be held liable for the damages suffered by a tenant in a sexual assault if adequate security was not provided, i.e., proper dead bolt door locks, secure windows, well lighted entrance ways and parking areas, etc.
Also, make sure that you have business interruption insurance. It is possible to have a $3,000 fire which is covered by your policy, but while everything is been handled, you lose $5,000 worth of rent. Some policies will exclude water damage if the house is not visited `every 24 hours’ while the owner is away. Be careful here. You could have an uninsured house if your tenant goes on a two week vacation. Make sure that you review your insurance on an annual basis, and KNOW that it is covering the replacement value. Also, keep a separate rider on your policy to cover any part-time employee’s actions while they are doing something for you. Remember, your tenant `could’ be ruled a part-time employee if he or she was fixing up the unit for a reduced rent.
WATER Make sure that you keep the receipts. (Perrier does not count here.) In many municipalities in BC we do not meter water so this may not apply.
OIL, GAS, HEAT, ELECTRICITY If you are sharing the unit, i.e., half a duplex, this can get complicated, even down to figuring out the respective heat loss from the main floor, and the attic, and arriving at a properly scientific percentage. What you spend is what you get. Do consider that, if possible, splitting services into two or more meters will likely SAVE you money in the long run. Rarely does a "heat and light included" tenant respect the cost.
TELEPHONE This is rarely a deduction for rentals. If you spend it, claim it. Just remember, a share of a single line personal phone rarely qualifies. The judge assumes that `everybody’ should have to pay for their own phone. TRASH HAULING This could be business, or it could be personal. You know the answer.
CABLEVISION You would normally only have this at `your’ expense if it was multiple and you lived on the premises. This is a good place to deduct the costs of tapes, etc., if you are supplying a video system.
ADVERTISING - RENTAL COMMISSIONS Self explanatory! Make sure that you keep the bills. A photocopy charge for pamphlets put up in laundry rooms would qualify here.
OTHER If you do not claim it, it will never be deducted. This could include collection charges, business license for bed and breakfast, food for bed and breakfast, an accounting fee, or perhaps a legal fee for drawing up a lease. Likewise, the common expenses for a condominium corporation would find a home here.
5) CCA-CAPITAL COST ALLOWANCE - DEPRECIATION (see Line 135 - business section)
Class 3 is any building you have bought since Jan 1, 1982. The rate is 2 1/2% for first year and 5% afterwards, on a declining balance. Class 3 also applies to a steel and concrete building bought before Nov 12, 1981. As of June 17, 1987 new buildings will be depreciated at 4%. Class 6 is any building of frame construction that you owned before Nov 12, 1981. The depreciation rate is 10%. Class 31 is a MURB (Multiple Unit Residential Building) of steel and concrete, bought before November 12 1981, or any MURB bought after that date. The rate is 2 1/2% the first year and 5% afterwards. Class 32 is a MURB of frame construction bought before Nov 12, 1981. Class 8 is the catch-all for the fridge, rugs, furniture, and fixtures. The depreciation rate is 10% in the first year and 20% in subsequent years.
All depreciation rates are on the declining balance
i.e., if there is a $1,000 addition for class 8, the depreciation in the first year would be 10% of $1,000 or $100, leaving $900 to depreciate for the next year. Next year, the depreciation would be $180 (20% of $900) leaving $720 to depreciate the next year.
If the item is class 3 or 6, no depreciation may be used to create a loss using classes 3, 6 or 8. If the item is class 31 or 32, depreciation may be used to create paper loss using classes 31, 32 or 8 (see david ingram’s Investment Guide for a great explanation of MURBs and how to let the government and tenant pay for your pension).
PARTIAL EXPENSES Use when you have a rental suite, half a duplex, or use part of the rental building for your own use. You might also use this when you have lived in the building for a couple of months of the year, and rented it out for the rest of the year. Simply divide your area into the total area, and take this amount off of the total of `partly’ deductible expenses. NET INCOME FROM RENTALS Put this amount on line 126 of the tax return. PROFIT OR LOSS After all that, if the property loses money, is the loss deductible? The answer is yes, if you can expect a profit in the future. If you are only renting out to `hold on’, you do not have a legitimate loss, as the following Toronto taxpayer found out. SPECIAL PROBLEMS Common situations that also cause problems are:
(a) rentals to members of your own family (see Virginia Maloney above) (b) rentals at unreasonably low rates to friends, business associates, or employees
(c) rentals of property where you use all or part of the premises some of the time for personal use In the first case, (rentals to members of the family such as your mother, father, brother, sister, son or daughter, or any of the respective in-laws), it is important to know that usually a loss cannot be created. If a father rents a building to a son and loses money in the deal, the tax office may not allow the loss because of the artificially low rent (i.e., renting a $500 per month house to a son for $100 per month). On the other hand, if the father was renting to the son at the same rate as to others and a loss was being incurred, the father should claim the loss as a tax deduction.
With regard to rentals to business associates or friends, we have a slightly different problem. If an employer provides a house for an employee at an unreasonably low rent, the difference between "fair" market value and actual rent charged should be added to the employee’s T4 slip as a taxable benefit.
6) CAPITAL GAINS WHAT ARE THEY?
This is provided for informational purposes only and should not be relied on without council from your Lawyer or Accountant
Too many big words, and very confusing! What is a "capital gain"? A capital gain is best described as an increase in the value of an asset when you do not really have any control over whether the value of the asset will go up or down, and where you do not normally "trade" in that asset as your source of income.
A capital gain is a gain which comes without effort on your part. It usually is a result of inflation, not of the marketplace, although you could say that inflation is a result of the marketplace, particularly when it refers to land and the demand for specific land. For example, waterfront or downtown commercial real estate makes some land far more expensive than the same amount of land in another area. You can see that the situation becomes very difficult when it comes to such cases as the stock market or the "entrepreneur" who buys an old house, lives in it while fixing it up and working at another job, and then sells the house at a profit. In many instances, gains that are normally considered capital gains become, in the case of stockbrokers who play the market, ordinary business income and are taxed at full rates. Furthermore, the tax-free gain from the sale of an "entrepreneur’s" personal residence should be considered business income since, in reality, this person has a part-time business.
WATCH First of all, if you sell your personal residence for a profit, you do not have to pay any capital gains. In the U.S.A. it is quite different. There, as a rule, if you sell your personal residence, you pay tax on the capital gain unless you use it to buy another house. Also, if the new house that you buy costs considerably less than what you received for the old one, there is often a taxable capital gain. The U.S. also makes provision for short term capital gains (taxable at the full income rate) for assets kept less than a year, and for a minimum tax when the total amount of long term capital gain exceeds certain criteria. In Canada though, it is another case of the rich getting richer and the poor not having a chance.
For example, if John owns a $100,000.00 house which he sells five years later for $150,000.00, he has $50,000.00 tax free, the equivalent of earning $100,000.00 at a job. George, on the other hand, has a $30,000.00 house he sells for $45,000.00, a tax-free profit of $15,000.00, the equivalent of about $22,500 earnings. This is hardly fair and is against the philosophy of our much-abused Carter Commission on taxation.
OPINION With regard to "how many houses", there is just no pat answer. If people keep on buying houses, fixing them the way they think best and, after finishing, decide that they do not like the result, why shouldn’t they sell and start over on other houses? But when is it a matter of disliking the finished product, and when is there an intention to make tax-free capital gains which are really very thinly disguised part-time business earnings? It is a matter between your conscience and the tax department. -
However, in December 1988, Harjit Atwal (I was his agent) was forced to pay full tax on a house which he built and lived in for a short while. He was a contractor at the time and built four similar houses for sale and one dissimilar house with a basement, etc. which he moved into. The judge ruled that he had not proven it was built for a personal residence. - In November, 1991, John and Valerie FALK They had had three houses in 8 years from 1980 to 1988. Revenue Canada Taxation tried to tax them on the second house they sold in 1985. The Tax Court of Canada ruled against Revenue Canada but Revenue Canada still tried to tax the house. Therefore, it should be obvious that you cannot "sell one a year", or move back into the rental house for a month to make it tax free. In fact, moving into the house to make it tax free, "triggers" a tax liability although it can be delayed.
ADJUSTED COST BASE Adjusted cost base usually refers to the original cost of an asset but, as the term implies, it may be adjusted by the owner for such things as the cost of improvements and additions in the case of a building, or annual property taxes and interest on undeveloped LAND. (Note: Undeveloped land must be held for development by a full time developer for interest and taxes to be written off. If you are a developer, the land will be taxed at full rates because it is a business action, not a capital gain).
In every case, these expenses cannot be deducted from normal income. It should be obvious here that, in the case of interest, every effort should be made to arrange your affairs to make this item deductible in the normal course of events, as there is a full deduction by deducting from income rather than by adding it to the cost base to give yourself only half the credit some years down the road when the dollar is worth less. Please note that cases mentioned in my TAX GUIDE show that judges are ruling against the deduction of taxes and interest on vacant land as either a straight deduction or by adding them to the adjusted cost base to decrease the capital gain.
In the Sterling case in 1985, the Supreme Court (by refusing to hear it) ruled against the deduction of interest for the purchase of gold. IN 1987, THE SUPREME COURT RULED AGAINST THE BRONFMAN ESTATE FOR THE PURPOSES OF DEDUCTING INTEREST WITH "SUBSTITUTED SECURITY".
PERSONAL-USE PROPERTY AND LISTED PERSONAL PROPERTY Personal-use property can best be defined as property that is valuable, but is used mainly for personal convenience or pleasure. If you lose money on personal-use property, as most people do with such items as boats, cars, planes, and household effects, you cannot deduct the loss. However, if you own personal-use property which you sell for over $1,000.00 and you make a profit over the adjusted cost base, you must pay capital gains tax on two thirds of the profit. In making the calculation, if your cost for the particular property was less than $1,000.00, your adjusted cost base is $1,000.00.
I find the most common articles on which profits can be made are antiques, although the tax office will also be checking the sales of fiberglass boats now, as their prices have risen by a phenomenal amount in the last few years. Also, if you have a vacation property by the beach which you sell at a loss, there is always the likelihood that the tax department may choose that this is a personal-use property for which you cannot claim a loss.
Listed personal property is a special kind of personal-use property that comes under the broad heading of collectors’ items. This includes antiques, paintings, manuscripts, coins and stamps. These are treated almost exactly as personal-use property with one exception: a capital loss from listed personal property can be used to offset gains from other listed personal properties, and it can be carried back one year and forward five years to offset other listed personal losses in those years.
SPECIAL NOTE -PRINCIPAL RESIDENCE This has always been a confusing one and to enhance that situation the department has changed the rules again. A family is allowed one residence tax free commencing January 1,1982. Therefore, a family may no longer enjoy a summer cabin plus the family home tax free. For those of you owning summer or winter cabins it would be very worth while obtaining appraisals on your real estate holdings as of January 1, 1982. Trying to sort out the January 1, 1982 market value of the cabin when you sell it ten or twenty years from now is going to be a very real, and likely expensive problem. Remember though, what you think is your principal residence for tax purposes can be ruled against by DNR. To claim your residence tax free, fill in form T2091 WATCH OUT
I also mention here that there is a four-year provision that allows your principle residence to be rented while you are away without changing its classification. The four years need not be consecutive; you could have been away in 1974 and 1975 and then returned for six months in 1976 before moving away again for another two years. If you are in this position you should file an election under Section 45(2) of the Income Tax Act indicating that your wish is to continue using the property as your principal residence and that you have not changed its’ use to rental property. Failure to file this election could cost you thousands of tax dollars.
If you are transferred and meet certain other requirements you may designate your home as a principle residence forever. Check with your tax consultant, as the rules are continuously changing in this area. Be particularly careful IF YOU ARE TRANSFERRED OUT OF THE COUNTRY and try and claim tax free status as a non-resident. This means that the old family house left behind becomes taxable in Canada and possibly in the other country as well (particularly if in the U.S.). 7) INVESTING IN REAL ESTATE Steer Clear Of Common Real Estate Blunders Copyright © Realty Times®. All Rights Reserved Real estate investment is a growing attraction for many, especially when the stock market doesn’t perform well. Everyone from first-time home buyers to seasoned investors are entertaining the idea of finding the perfect real estate deal. But developing long-term wealth in real estate requires an understanding of some basic blunders that could help avoid costly mistakes.
Here’s a look at some common errors to help you avoid a real estate transaction disaster.
Leaping into Real Estate without a Plan and Vision.
That’s like starting a business without knowing what product or services you’re going to sell; it’s unlikely you’ll get very far with that approach. Or it’s like going on a road trip without the map, [People] end up with a [real estate] portfolio without any idea of what they’re really up to, or what their targeted goal is, or how long they want to own that property, or what types of different properties they want, or what rate of return they want from the equities they’re building.
Thinking That You Don’t Have Enough Money to Invest.
Even though interest rates are starting to creep up, there are still many good loans available where you don’t have to put 20-30 percent down. But remember, if you’re putting less down, your monthly mortgage will be higher, and if you’re purchasing an investment property, keep in mind that you must be prepared to sustain a negative cash flow for a period of time.
If you absolutely have no cash, you can certainly get no-money-down deals. You’re just going to pay for it. You’re going to pay a higher point. You’re going to pay a higher interest rate. But if it’s still a good deal you can go with no money down. It just means it’s more expensive to get started in the game..
Flipping Property too Quickly.
When appreciation is high as it has been in some markets such as Vancouver & California, often people tend to want to buy real estate and sell it quickly to turn a profit. But the real benefit is in the long run.
[Investors] will actually hold on to [real estate], keep all of the gain through all of the cycles that [they] go through. Then, at the end of their plan, all of a sudden they’re sitting with a lot of gain, not only [from] tax benefits, but also the equity from appreciation, over time the loan will be paid down and typically rent will have increased.
Focusing only on Active Income.
Most of us never forget to think about our active income, the income from our 9-5 job, but we often fail to pay attention to our passive income streams, such as money that can be generated monthly from rentals. Leverage is a major key to building wealth. Having a tenant pay for your investment is leverage!
Not Building a Real EstateTeam.
Surrounding yourself with the best experts from the real estate agent to the financial planner will help you achieve your desired outcome faster and with fewer headaches than if you go at it alone. Using the experience and knowledge of others is key to avoiding costly mistakes, and their guidance and advice can be worth their weight in gold.
Spending your return on your Investment.
Take your hand out of the cookie jar. If you have a positive cash flow on a property, evaluate where the money should go; you might consider taking some equity and combining the positive cash flow to reinvest in another rental.
Expecting a Positive Cash Flow from all Real Estate.
When you calculate cash flow, appreciation, loan reduction and tax benefits, (including interest write-off and depreciation) having a negative cash flow is not necessarily a bad thing. Usually a negative cash flow on a property won’t be for a long period of time. In a perfect world, all of our investments would generate positive cash flow with double digit appreciation. Unfortunately, we don’t live in a perfect world. The big appreciation usually comes in markets where you have negative cash flow. This expands on the "balanced portfolio" mantra. Vancouver is a perfect example of a market that is difficult to find a property that will give you a positive cash flow. However, it is also widely predicted that our prices will continue to increase sharply.
If you’re uncomfortable supporting a negative cash flow scenario, you may want to take a look at a property in a less explosive market. It isn’t difficult to locate properties in markets that can produce a positive cash flow. You can build a portfolio that supports itself! There are multiple benefits to this.
* you can offset some of that negative cash flow
* you can be geographically diversified
* even though the appreciation in the positive cash flow area might not be as attractive as in the faster growing area, there is a good possibility that the return on investment will still be extremely strong (based on leverage) when compared to that of other financial markets.
Most critically, the longer an area has been rapidly appreciating, the worse the cash flow scenario typically is, and here’s why.
Just before a market takes off, the Rent to Sales Price ratio is usually decent. This is because there are less investors buying rental properties in the market, creating a shortage in available rental properties. This shortage drives up the rent. This increase in rent entices more investors to buy property in that market, increasing the supply of rental properties (softening the rent prices) and increasing the demand to buy these properties. As prices go up due to the higher demand, the cash flow scenario worsens until investors no longer fight over the properties. This reduces the demand for the properties, again drying up the rental pool, again causing an increase in rent. Sometimes the rent and the sales price are in balance providing a decent but not exceptional cash flow, stabilizing the market.
This is a typical market cycle, and the most public display of this concept is exhibited in Las Vegas and Phoenix right now, albeit these two markets are on opposite ends of the appreciating market.
Las Vegas has already experienced a (sustained) rapidly appreciating market, and the prices have increased as high as 50% over the last year. This has led to a glut of rental properties, and rent has actually gone DOWN. With Sales Price skyrocketing and Rent slightly decreasing, the cash flow scenario is not so cheery. You might ask why would people still buy in Las Vegas, and the answer is that some are happy with the appreciation they are making and are willing to accept a few hundred dollars a month negative cash flow when they are seeing a 1% (or $2.000+) increase in the value of the property.
In Phoenix, the prices are still low, and the rent is still decent. Since they are still appreciating, the cash flow scenario is getting worse, but they are still positive cash flow in many cases, even with 5% down. As there are MANY investors in Phoenix as many investors left Vegas for Phoenix, there is potential for there to be a glut of available rental properties, which would lead to a negative cash flow scenario. (At their current appreciation rate, this may not occur for quite some time, but it will eventually likely happen.) Many real estate investment advisors recommend to NOT get into a negative cash flow scenario. I’ve heard of some recommending that you run the scenario at 20% down on a 30 year fixed (even if you’re using a 5/1 ARM 5% down), and if it pencils out positive this way, then it’s a decent investment.
I don’t advise my clients either way. This is a conservative approach, but understand the concept of accepting a REASONABLE negative cash flow if you feel strongly that the appreciation is going to be strong. Basically, it all comes down to whatever risk level you find acceptable
Consider what you are paying into your RRSP. Every single month many people make a contribution to their retirement plan. Why do people consider a contribution to real estate anything different, if you know what your rate of return is for the money that you’re putting into it?
Not diversifying your portfolio.
A real estate portfolio should be diversified much like a stock portfolio. "You might have a couple of condos, a couple of apartment buildings, you might have a couple of single-family residences, you might decide you want to buy some raw land, or consider investing in a city, province or state, where the market is not as active right now.
If one market isn’t performing as well, you can still rely on the other real estate investments.
Not understanding real estate tax benefits.
Owning real estate has powerful tax benefits. Strategically using them to your advantage is key to developing long-term wealth. Most people don’t understand that there is tremendous power and long-term benefit through the use of depreciation and the interest write-off on the loan. And it’s the misunderstanding of the depreciation that is very common among beginning investors. Talking to your financial advisor and understanding how to properly set up your investment for tax purposes is key.Sticking to your desired outcome.
Whether it’s your first home or your fifth investment property that you’re wanting to buy, staying committed to the end result will get you there. You have to keep the vision and the plan firmly planted in your head. Writing down and sharing your goals and fulfillment dates with others will help make you accountable and keep you on track.
8)Deductibility of Leaky Condo Fees
Here is a Question and Answer to an investors questions regarding deductibility of repairs for a leaky condo. Again this is for informational purposes only and you should always consult with your lawyer and or accountant for timely advice. More information can be found at:
COLCO: Coalition of Leaky Condo Owners www.myleakycondo.com P.O. Box 16041, New Westminster, B.C., V3M 6W6 Canada
Telephone 604-739-4190 Fax 604-739-4109
QUESTION: I am somewhat familiar with the tax deductibility of repairs on a rental leaky condo against current income, but I wish to learn as much as
possible about the various scenarios, CCRA rulings, what constitutes
current income, etc.
In particular, I recently bought a unit with the full intent of renting
it out, but prior to that I lived in it for a period so that I could
facilitate major upgrading and renovations. It was during that time
that it was discovered that the building was a leaky condo. Does my
intention to rent at the time of purchase provide me with grounds to
deduct repairs?
There is no "for sure" answer to this question but I will try. 1. Any major upgrading and renovations that you made before renting are NEVER deductible against current income. They are added to the building cost and are depreciable at 4% per year but only up to the amount of profit from the rental income. 2. If an already rented condo "suddenly" needs unexpected repairs because of water damage the repairs should be deductible and can be used to create a loss. This loss which would show up on line 126 of the tax return would be deductible against other income from wages, business, interest, dividends, royalties, etc.
3. IF and I say IF, the paperwork showed your intention to rent and you are only talking a couple of months between "buying", moving in to renovate, and then advertising it for rent when you find out it is leaking, you could certainly have an argument that it was and unexpected item and should be a repair.
However, if you bought it and spent a year renovating and "then" discovered the need for leaky rotten condo repairs, it would not be a repair. Anything more than 90 days for the renovations (in my opinion) is too long a time between the purchase and intent to rent. I am not the judge, and other circumstances might have slowed down your rental plans. I can almost guarantee that you would be audited and would likely have to go to court and would have a tough time with 2 but win and would be unlikely to win in 3 above.
Also, the renovations are almost finished but the unit may not be
rentable, because no tenants as of yet, wish to rent it given what they
will have to go through when the building envelope reconstruction
starts.
This extra statement implies more than 90 days already. I think you are
faced with adding your repairs into the Adjusted Cost Base of the unit.
9) Understanding the Twelve Keys that Drive Real Estate Values 1) Mortgage Interest Rates Low interest rates allow a greater proportion of renters to become homeowners, which in turn can lead to an increase in home sales and therefore push prices higher. That said they don’t significantly increase mortgage costs (on a $100K mortgage a quarter % increase in rates only increases the payments by about $14). 2) Net Wealth Effect Increase in Disposable Incomes This is one of the most important indicators. If a town’s average disposable income is increasing faster than the national average real estate prices are poised to do the same thing. Key Indicators: a) increased average income; b) decreasing income tax rates; c) increasing retail sales. Be wary of towns where demand is driving values upward while the average income is remaining flat. Go to www.rbc.com, then to economics to find the housing affordability index. As a rule of thumb a well-balanced market for investors is a market that has a housing affordability index of about 33%. 3) Increased Job Growth and In-Migration It pays to read the newspaper regularly in the towns you invest in. Be on the lookout for announcements of new jobs, major expansions, or new employers moving in. Find areas where the population is growing faster than the provincial average and gaining a good reputation. Also look for Immigration- people from other countries moving into the area, and Intra-migration- people moving from other parts of Canada into the area.
4) The Real Estate Doppler Effect It is often much more profitable to invest in areas surrounding the boom than to buy property in the heart of it. Use this factor to identify areas that are poised for a strong increase in demands. Smaller cities, outside of areas that get the effect, usually take 6 months to catch up. Look for towns where redevelopment is occurring. Older untouched neighborhoods in these areas can sometimes be hidden gems that aren’t immediately affected by a boom. 5) Local, Regional and Provincial Political Climate Business friendly politicians generally equal real estate friendly investment areas. Look for regions where development is wanted, not shunned. Look for areas with forward-looking economic development offices where they sell the area to potential employers. Progressive towns attract business while other towns lose it. 6) Critical Infrastructure Expansion Here’s another reason why reading local newspapers in areas that you pan to invest in will pay off for you big time. Look for planes, trains, highways, sewers, land annexation or expansion plans. But remember… DON’T BUY UNTIL YOU SEE SMOKE! Never buy based on rumors alone. Trains and rapid transport are huge (i.e.: towers that spring up at subway stops). Buy within 800 meters of the station, or exit/entrance etc. 6b) Increased cost of Labour and MaterialsThis occurs in areas of high in-migration and infrastructure expansion, labor and material costs will increase dramatically. Look for regions where there is a marked increase in these costs as a sign of future value increases. The value increases occur around six months after the cost of new building increases. 7) Areas of Gentrification and Renewal If chosen correctly this consistently provides the biggest bang for investment dollars. This is best defined as areas that are moving up from one economic class to the next, often described as “tough, yet funky”. In these areas, you’ll witness a mix of run down to well-kept, recently fixed up properties. Often you’ll see these areas mentioned in the news. Every city and most towns have areas like this. The local perception is the hardest to change, so often locals miss the opportunity. Insight: Look for Doppler Effect gentrification areas. Never be first into an area you believe is going to be in transition. Renewal areas take more due diligence but are worth the effort. The Active Factors These Factors we can influence. Each affects the overall value of a property. 8) Maximizing value and Zoning opportunities Sophisticated investors look first at properties physical attributes, and then they examine how they may be able to change the property to optimize profit way beyond just renovations. IE: an old hotel that is converted into loft apartments, taking a single family home and converting it to a duplex. You need to know zoning bylaws and tenant regulations to make the transition successful. A small percentage of properties will have this potential, but make sure you have the required finances and expertise before taking this on, or find a partner. 9) Buy Wholesale- Sell Retail You can buy properties at wholesale any day of the week in any town across the country. There are companies whose sole business is buying properties this way. I.E. Buying an apartment building and turning the apartments into condos in an area where condos sell for 80K, and you can buy the building and do the conversions for an average of 50K. Development of raw land also falls under this. Another way is to buy properties that are going to foreclosure. In Canada, accessing these properties is tougher than in other countries. In the US, it is very easy. The best market is the pre-foreclosure market where you proactively advertise to buy such properties. 10) Stand out from the crowd Quality marketing is a real estate investor’s best kept secret. You must be proficient to get above market rents and values for your properties. I.E. Two similar houses where one is properly marketed can easily sell for 5-10% more than the other can. Matching your message to your prospective target is critical. 11) Renovations and Sweat Equity Areas in transition are great sources for homes that need improvements. Look for well-built but neglected homes. Keep the work simple and in line with what a renter or owner is looking for. Improvements can also be landscaping and exterior work. 12) Speculation, jumping the gun on a wish & a prayer! Speculators forget about economic fundamentals, and neglect doing homework once again, proves emotions lead to bad decisions, and is the downfall of most real estate investors. Match potential investment areas against the 12 components. In today’s market you are looking for at least 7 of the 12 components to be in-line before purchasing. Other Due Dilligence Steps - Pick up the local newspapers
-
Drop by the public library -
Pay attention to business moves -
Study housing prices -
Look at vacancies -
Visit the local Chamber of Commerce -
Visit local business owners
|
