I have always loved the idea of passive income, and investing in rental real estate is one of the best ways to materialize the idea.
Real estate investing is a popular option among inventors looking for relatively more aggressive or alternative investments to the traditional stocks, bonds and CDs.
Investing in rental real estate properties allow owners to benefit from monthly cash flow in form of rent, without necessarily having to perform any additional work. Without going into debate over whether passive income exists, it is because of this that rental real estate is considered an investment that generates passive income.
In addition to passive income, because investing in rental real estate can be a both a passive and active endeavor, an investor can benefit from significant tax deductions from either.
For example, many rental property owners do not live in the rental property, and therefore expenses to maintain the property can be more than rents received, particularly in a struggling economy like we are in today where there could be some vacancy (time the property is unoccupied by a tenant).
When expenses exceed the gross rental income, losses are generated from the investment activity that can be used to offset profits from earned income or income from employment.
There are certain rules and regulations that govern the treatment of rental losses for tax purposes however. These rules are called “at risk” and “passive activity loss” rules which limit the use of rental property investing related losses for any given tax year. Losses resulting from passive activity can only be claimed as deductions to the extent of income from that activity.
The excess losses can be carried forward to the following year or years until used, similar to losses from capital investing wherein you are allowed to deduct $3,000 each year and carry forward the rest. If and when you dispose the underlying asset, in this case the rental real estate, you are entitled to take all of the remaining carry forward loss balance in the year of disposal.
Basically, losses from rental real estate that are limited by passive loss rules are merely delayed and not wasted. You have to be careful and keep track of unused loss deductions as it is easy to forget.
There is an exception to this rule however. If you are actively (not passively) involved in the rental activity, you are then allowed a deduction of up to $25,000 in excess of income generated by the rental activity, phased out for every dollar exceeding $100,000 in adjusted gross income (AGI).
These figure can vary based on the tax law at the moment. But the underlying premise is that if you are actively involved, you can deduct more losses than if you were only passively involved.
Does active mean regularly unclogging the kitchen sink? No. As long as you can prove you were actively involved in the management of the rental property, you should be able to take deductions you are entitled to.
Hope I was able to highlight just some of the benefits of investing in rental real estate. I will be discussing this topic in depth in the coming weeks, focusing on real estate investing from a broader and in-depth perspective.
It is one of my favorite forms of investments as it is one of the best ways to generate passive income, diversify your investment portfolio, build wealth and hedge against inflation all through one investment vehicle.
Readers: Do you have any real estate investments? Are you planning on investing in rental real estate at some point? Why or why not?
Here are my thoughts on value investing in rental real estate, which beats speculation any day in my opinion.