Four Critical Questions To Ask Yourself Before Investing In Real Estate
Investing in real estate can be an exciting and rewarding venture. There are many factors that need to be taken into consideration in order to start off in the right direction. Before embarking on this journey, it is important to determine what type of investor you want to be, what your investment horizon is, what your goals are and what the potential tax benefits may be. Asking yourself these questions will help maximize your chances of real estate investing success.
Do I have the time and expertise to be an active investor, or would it make more sense to be a passive investor?
You can divide real estate investors into two categories: active and passive. Both approaches can help you earn additional income and build long-term wealth. However, depending on your goals and a couple of other key factors, one path will be better suited for you than the other.
Considering your lifestyle, obligations and time constraints will help you determine the best option. If you like the idea of sourcing properties, securing financing and being a landlord, active investing may be the perfect choice for you. However, if you don’t have time to deal with properties and tenants, you may want to consider passive investments. This would not require you to engage in daily real estate activities.
Deciding between active and passive investing can have an impact on the specific investment opportunities you pursue and how much it costs you to get started.
What is my investment horizon?
Defining your investment horizon, or timeline, is critical with any investment, and as such, the need for liquidity will most likely guide you. Will you need the availability of liquid assets in the near future? Would you be able to meet financial obligations if an unexpected event occurred and you required funds that were tied up in real estate? When it comes to real estate investing, make sure you know if and when you will need liquidity and, if so, whether the particular investment can fit within your specific needs.
What makes a particular investment attractive to me, and how do I determine the success of that investment?
Some investors are drawn to the idea of short-term fix-and-flip investment opportunities and enjoy rolling up their sleeves and slinging hammers. While this may add to the excitement of real estate for some, it may not interest everyone. Other investors prefer to stay away from hands-on work. Knowing which you prefer will help you determine a vision of what success in an investment could look like.
Most investors will first look to some sort of return goal over a certain period of time to define success. However, success could include other aspects, benefits and/or responsibilities. Determine what your idea of a successful investment is, and outline the steps you would need to take in order to achieve goals.
What are the potential tax benefits?
Real estate investments, whether active or passive, can offer tax advantages. However, the exact tax benefits available to investors will depend on the particular investment.
For the passive investor, the Tax Cuts and Jobs Act (TCJA) allows for income earned through pass-through investment structures to qualify for a 20% tax deduction. Further, the TCJA allows both active and passive investors to invest in qualified opportunity funds. Opportunity funds offer capital gain tax incentives to investors, including the opportunity to defer and reduce capital gains taxes for monies invested into opportunity funds.
Active investors can take advantage of 1031 exchanges, which offer investors a way to defer capital gains taxes on their initial investment indefinitely. There are other features within 1031 exchanges that make it a useful tool for estate planning purposes for some active investors.
While real estate investing is full of exhilaration, risk and potential rewards, it is crucial to understand what you are setting out to accomplish. Knowing your vision and goals will help you determine what type of real estate investing is best for you. Will you be an active investor or a passive investor?